Markets unenthusiastic for Greek bailout

Markets have greeted the announcement of the intended ‘bailout’ for Greece with relatively little enthusiasm, perhaps because they fear a domino effect of debt write downs elsewhere or perhaps because they already know that the policy prescriptions will not be enough to save the Greek economy from a long and protracted slump that could yet force a political backlash against the Euro. Deep austerity, economic depression, social unrest and the suspension of democracy have been features of the Greek state for some months now but the terms of the Greek bailout suggest that the economy will shrink by at least another 5% this year (perhaps nearer 10%?), which will likely lead to more tensions within Greece’s social and political fabric.

While Hong Kong experienced deflation following the Asian Crisis of 1997, and the Baltic Region has also experienced an internal depreciation, no established country with a unionised workforce and democracy have faced the more than 50% deflation of disposable incomes that is being demanded of Greece. Proponents of the internal depreciation route point to Ireland as being a ’successful example’ of such a policy but this is not in fact true: headline unit labour costs have fallen, but this is in a sense a fictitious number caused by the arithmetic impact of a fall in construction activity on the average productivity data. On a sector specific basis, there is little or no evidence of wage deflation or a productivity boom in Ireland over recent years. With this in mind, it looks as if Greece is being asked or required to achieve the impossible.

There are also issues for capital raising. Since in effect official sector holdings of Greek bonds will be largely exempt from any write downs, the cost of the write downs will fall disproportionately on the private sector holders of the debt and this will affect the Euroland peripherals generally.

However, before we become too concerned over the costs to Greece’s existing private sector creditors, we should also note that the bailout plan calls for a public sector sponsored capital inflow into Greece.

Throughout the early to mid 2000s, Greece was able to attract very high levels of private sector capital principally but not exclusively, from German banks. It looks as if over the 30 months which followed the start of the global financial crisis, Greece attracted some €130bn alone and on top of the €150bn they had already attracted in the previous three to four years. These flows may be seen as misguided, but were nevertheless discretionary flows, organised and sponsored by the private sector. Perhaps the Greeks were ‘wrong’ to use these flows to fund a drop in their own national savings rates (not that they were alone in this practice) but the ‘investors’ were also demonstrably wrong to send so much money in the first place. In contrast, the latest inflows into Greece will be exclusively public sector in nature. This makes Greece in effect, the ‘ward’ of the troika and implies that taxpayers are being compelled to finance Greece and to some extent protect the interests of Greece’s former investors.

Overall, the key attraction of the Greek plan is that like the LTROs and TARGET2, it prevents a systemic financial collapse in the near term and therefore buys time to build more firewalls and contingency reserves in case politics forces the Euro to split in the future – and maintaining it is costing taxpayers a fortune and social misery in parts of its area. But to dismantle it now would not be a safe prospect for the global financial system. The bailout for Greece was and is necessary , but could have been done without the excessive conditionality, ostensibly required to avoid “letting the Greeks off”, but now threatening a political backlash that may well yet sweep Greece from the Euro later this year or next.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla