The View

Euro loses in Greek numbers game

PUBLISHED : Tuesday, 07 July, 2015, 11:07am
UPDATED : Tuesday, 07 July, 2015, 4:15pm

However the latest phase in Greece’s financial crisis plays out, the euro zone and its institutions will have to share Greece’s pain, and that does not bode well for the value of the euro.

“If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem,” US industrialist J. Paul Getty once said.

How about if it is 240 billion euros that cannot be repaid?

That is what Greece has received in two bailouts from the European Union (EU) and the International Monetary Fund (IMF) since 2010 of which the vast majority is owed to the country’s EU partners, in one guise or another.

Yet, according to an IMF Debt Sustainability Analysis published on July 2, even before Greeks rejected yet more austerity in July 5’s referendum, Greece’s public finances cannot be sustained without substantial debt relief, relief which might have to include write-offs of EU-provided taxpayer-guaranteed loans.

Those loans include 52.9 billion euros in bilateral loans, provided by euro zone governments, under the first bailout agreed in 2010, and 141.8 billion euros dispensed under the terms of 2012’s second bailout, sourced from the euro zone’s financial rescue fund.

It is euro zone governments who must also ultimately guarantee that financial rescue fund.

As for the European Central Bank (ECB), its holding of 18 billion euros of Greek Government Bonds would plummet in value if Greece were to exit the euro zone, the so-called Grexit scenario.

But in the numbers game, 18 billion euros are just the tip of the iceberg as the ECB has also already extended, according to its President Mario Draghi, some 118 billion euros of central bank liquidity to Greece’s banks.

And then there are the 45 billion euros of banknotes in Greece itself, a liability which, in the event of a Grexit, becomes a claim that the wider Eurosystem of central banks would be obliged to cover.

Perhaps those kinds of numbers help explain comments made by former Federal Reserve Chief Alan Greenspan in May.

“Who stands behind the ECB?... The question is if there is a run on the European Central Bank I’m not sure where they go,” Greenspan said

While that would be an apocalyptic scenario, Greece owes serious money, and the bottom line is, as the IMF has said, Athens cannot repay what it has borrowed, under the terms it was lent, and indeed will require another 50 billion euros in additional aid over the next three years just to stay afloat.

One way or the other the euro zone institutions that have lent money to Greece, in good faith, are going to have to take a substantial hit, and when markets grasp this, their valuation of the euro should be adjusted lower.

A Grexit would also shatter the belief that the euro is indivisible.

Paradoxically, a realisation that not all the money loaned is ever going to be repaid may also underscore why the euro zone and the IMF have refused the type of concessions to Greece that the Athens government has been holding out for.

If it is accepted that at least some of the loans will not be repaid under any scenario, then the appetite of the creditors, to provide Greece with concessions is reduced, lest giving ground to Athens encourages other countries to backpedal on their own austerity programmes.

In truth, a Grexit, or any form of deal that realises losses to Greece’s creditors, as it should result in a weaker euro, would also give euro zone exporters more of a competitive advantage in the global market-place.

In this endgame, Greece and its creditors both end up embracing a sub-optimal outcome as the best that can be achieved, a weaker euro is collateral damage.

Emerging market central banks seem to have grasped this better than most.

“Emerging and developing economies reserve holders remain reluctant to purchase euros providing no offset to the sharp decline in the value of the euro. They even sold euros into weakness at the end of last year,” Japan’s BTMU wrote, in an analysis of the IMF’s June 30 Currency Composition of Foreign Exchange Reserves (COFER) report.

Holding back on new purchases of euros might prove to have been prescient.

Greece can’t pay and, to coin a traders’ phrase, the euro zone is wearing a bad position.

The euro will have to take the fall.