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They have to be very careful as all the national govts are subject to a liquidity crisis.

If all the national govts had started with zero debt when they formed the union, the markets never would have let them get beyond maybe 20% debt to GDP.

(Note that Lux never did have its own currency and never did get that high.)

Instead they came in at the 60-100+ debt to GDP ratios they got to when they had their own currencies when it didn’t matter for liquidity/funding purposes, as with their own currencies liquidity and solvency wasn’t an issue, and whether they knew it or not their deficits were simply offsetting the economys’ nominal savings desires at the then current exchange rates.

So all (except Lux) came into the new single currency with highly problematic debt ratios, and a ‘promise’ of bringing them down. This promise had enough credibility to get them through, but markets are telling us the recession has cast serious doubts on the current institutional structure being able to bring its debts down and get itself out of ponzi.

Germany lending to Greece does not reduce the overall debt to GDP of the Eurozone. In fact arguably the introduction of ‘moral hazard’ issues make it worse as there’s a reasonable chance with this kind of implied umbrella Greece and others will feel they’ve called the union’s bluff and not adjust their finances accordingly. And, worse yet, markets are coming to understand that fiscal austerity can backfire and cause deficits to increase as it causes the economies weaken further, making it a lose-lose scenario.

So yes, the announcement of aid beyond loans will buy some time, but without sufficient real growth driven either by exports or domestic credit expansion (which is also not sustainable longer term) all the same issues will probably return.

And one of the reasons for the weak euro has been that their deficits have gotten large enough to make euro financial assets sufficiently ‘more plentiful’ to weaken the currency. This kind of help doesn’t change that.

And it could be that one of their goals is a policy that weakens the euro in an attempt to improve exports, while at the same time not triggering a liquidity crisis. Seems like an impossible tightrope to try to walk.

The easiest/safest way to do that is for the ECB to buy fx, but their ideology doesn’t allow that.

>   (email exchange)
>   On Wed, Feb 10, 2010 at 6:14 AM, Dave wrote:
>   Bunds off almost a point on this story
>   Curve bear steepening
>   DV

Germany Said to Consider Greek Aid Beyond Loan Guarantees
2010-02-10 10:10:02.560 GMT

By Brian Parkin

Feb. 10 (Bloomberg) — German Finance Minister Wolfgang Schaeuble told lawmakers that options for helping Greece extended beyond loan guarantees, said an official who attended a briefing today at the Parliament in Berlin.

Officials were told that European Union rules on aid were more flexible than the government originally thought, according to the lawmaker who spoke on the condition of anonymity because the discussions were confidential.

Lawmakers were briefed on the legal aspects of an EU member state providing financial help for another and were told to digest the information quickly, the lawmaker said. The German parliament must back any move to help Greece, he said.


4 Responses

  1. Warren,

    How big of a factor if any do you think the role of German banks (as well as others) holding Greek debt plays in their bailout? Could they even walk away if they wanted to?

  2. A weak Euro would also help with tourism – a major industry in Greece.
    How major? Greece, with a population of 11m people, gets 18m tourists per year. By comparison, the US with 300m people gets only 56 tourists. So just imagine if the US got the Greek-equivalent ratio of tourists, 490m, or close to 1/2 billion tourist, and you get a sense of how important the industry is to Greece.

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