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Brussels, We’re Not Receiving YouDetails of the "plan" remain sketchy. The entire package conveys the impression that the EU and ECB are hopeful that the announcement will suffice to bring stability to markets and the facilities won’t ever have to be used.A problem of too much debt was being solved with even more debt. Deeply troubled members of the eurozone were trying to bail out each other. Given that all have significant levels of existing debt, the ability to borrow additional amounts and finance the bailout remains uncertain. The reality is that Germany, with its large pool of domestic savings, must be the cornerstone of the rescue effort. Predictably, German credit-risk margins have increased while the peripheral countries’ credit margins have fallen. The effect of the stabilization fund is that stronger countries’ balance sheets are being contaminated by the bailout. Like sharing dirty needles, the risk of infection for all has drastically increased.Karl Dunninger, a trader, writing at www.seekingalpha.com captured the madness:
The most-amusing part of this is that nations seriously in debt and without a pot to piss in will be "contributing" some of the money to fund the debt. Spain, for instance, has pledged to do so. Where is Spain going to get the money from? Will they sell bonds at 8% to fund a loan at 5%? That's a very nice idea... let's see, we lose 3% on those deals. That ought to help Spain's fiscal situation, don't you think?
Solvency Not Liquidity, StupidAt best, the plan provides temporary liquidity to cover immediate financing needs, repaying maturing debt, and financing deficit. In a striking parallel to the early stages of the GFC, the reality that it’s a "solvency" problem not a "liquidity" problem remains unacknowledged.Most of the countries in the firing line have unsustainable levels of debt. For example, beyond 2010, Greece needs to re-finance borrowings of around 7%-12% of its GDP (around Euro 16 billion to Euro 28 billion) each year till 2014. There are significant maturing borrowings in 2011 and 2012. In addition, Greece is currently running a budget deficit (currently over 12% but projected to decrease) that must be financed. As noted above, Greece’s total borrowing, currently around Euro 270 billion (113% of GDP), is forecast to increase to around Euro 340 billion (over 150% of GDP) by 2014. The IMF’s publicly available economic analysis that its plan assumes is that Greece is able to refinance long-term debt by early 2012 and short-term debt even earlier. Given that Greece is expected to have a total debt burden of around 150% of GDP and total interest payment of 7.5% of GDP, the ability to raise funds and the assumed 5% cost of refinancing may be optimistic. The IMF plan calls for a program of fiscal austerity and major structural reform. This would entail a sharp reduction in the budget deficit to less than 3% of GDP and public debt under 60% of GDP. It’s unlikely that Greece, despite heroic speeches from politicians, will be able to meet these targets. Temporary emergency funding won’t solve fundamental problems of excessive debt and a weak economy. Government expenditure will need to be slashed and taxes raised to reduce its debt. But the government is too large a part of the economy and the suggested austerity measures will most likely cause a severe recession. In turn, this will drain tax revenues and increase expenditures, making it difficult to reduce the budget deficit and funding needs. The level of indebtedness may already be too high. Kenneth Rogoff and Carmen Reinhart in their survey of financial crises This Time Is Different argue that sovereign debt above 60-90% of GDP restrains growth. Greece’s interest payment now totals around 5% of GDP and is scheduled to rise over 8% by GDP. Rising interest costs will only worsen this problem.The cure may not be feasible or won’t help make it easier to meet future debt obligations. Ireland has already implemented austerity measures. The government debt as a percentage of GDP has increased to 64% from 44%. The budget deficit as a percentage of GDP has doubled to 14% from 7%. The nominal GDP of the country has fallen by 18%. The plan may also make further liquidity problems inevitable. Instead of allowing Greece to raise funds normally, the bailout package is assisting investors to reduce exposure via repayment of maturing debt and the sale of illiquid longer-term securities. The package also risks forcing other vulnerable countries to rely on the stabilization fund. As Woody Allen once observed: "More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other, to total extinction. Let us pray we have the wisdom to choose correctly."
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