The PIIGS have landed. What now?

“She can’t do with him, she can’t do without him,” she said, as soon as I got back home and sat down on the bean bag.

“Who?” I asked, having a glass of nimbu paani.

“My friend L. I told you na, she dumped J again... well, now she is
missing him.”

“Oh. They are bit like the European Union countries. Together they are in a mess and they cannot do without each other.”

“Ye lo. I was talking about my friend and you have as usual taken the discussion to an entirely different level. Now please explain.”
“Sure. The day the bailout package for the PIIGS (Portugal, Ireland, Italy, Spain and Greece) was announced, the stock markets around the world roared. Since then they have been going downhill. Why is that?” I asked.

“You tell me. You are the expert here, I just listen.”

“Well the stock markets took some time to realise that the mess that Europe is in is not very different from the mess the US has been in for a while. Both have a problem of having more debt than they can pay, though there is a slight difference. In the US, the excess debt is both at the individual as well as the government level whereas in Europe, the debt is largely at a government level.

As Bill Bonner, a well respected newsletter writer wrote in a recent column, “For many years, we pointed the finger at Americans, claiming that they spent too much money. Americans lived beyond their means. Individual households overspent and went into debt… In Europe, the phenomenon is a little different. It’s the public sector that is living beyond its means… social spending is responsible for a big part of the gross domestic product (GDP) and a big part of living standards. But as in the US, living standards are higher than people can afford. Governments provide more employment, more transfer payments and more ‘services’ than they have tax revenue to pay for. Europe, generally — excluding England — does not have high levels of private debt. The debt is in the public sector.” And that’s what has got them into a lot of trouble.”

“And how are the comparative numbers looking, V?” she asked with the ease of a professional.

“As Bonner points out, “Government debt in Europe, on average, is no worse than it is in the US. The Eurozone, altogether, has government debt-to-GDP of 88%. In terms of deficits, Europe is actually in better shape than the US. US deficits are running around 10% of GDP — or more. In Europe, the average deficit this year is expected to be 6.6%.” So the situation in Europe is not very different from the US, when the crisis started. Also, the PIIGS economies are in deeper trouble than these average numbers show.”

“So what is the market making out of all this?”

“What they are realising is that this rescue is similar to the $700 billion troubled asset relief programme (TARP), the first bailout in the US, initiated in March 2008, at least to the extent of the amount of money being bet on it. As David Rosenberg, chief economist at Gluskin Sheff, a wealth management firm, wrote recently, “Recall the initial reaction to TARP — shoot first, ask questions later, buy some time. As the TARP initiation showed, it is one thing to announce a big and bold rescue package, but it is quite another task to have its credibility built and actually initiate the plan with no wrinkles. Good luck. Back then, a huge immediate relief rally of 11% gave way to a 30% slide to the lows — the bottom was only turned more than four months later.”

“So from the looks of that the stock markets will keep falling for a while?”

“Yup. The other factor being that funds from the $962 billion rescuepackage will be disbursed only if the troubled economies follow structural reform and fiscal management programmes monitored by the International Monetary Fund. Fiscal management will require governments across the troubled economies of Europe to cut costs, which is going to be a politically difficult proposition in the current recessionary environment. Let me get into some detail. The “Stability and Growth Pact” adopted in 1997, on which the foundation of the euro rests, suggests that countries that use the euro as currency need to maintain a fiscal deficit of up to 3% of GDP, and have a public debt of up to 60% of GDP.

Currently, only 3 out of the 16 countries that use the euro follow this norm. Greece comes at the top of the offender list with a deficit of 14% of GDP and a debt-to-GDP ratio of 115%. It need not be said that the PIIGS economies do not meet these norms either, neither do some other countries in the Eurozone.”

“So what will happen to the PIIGS economies if they try and follow this?”

“During recessionary environments, government spending is one thing that really perks up any economy. In order to manage the deficit and cut on debt, government spending will have to come down, but politically, it may not be such an expedient thing to do.

As Rosenberg points out, “It will be interesting to see how Spain can manage to meet… deficit requirements at a time when the unemployment rate is currently at 20%.” At the same time, any cut in expenditure will have an impact on GDP growth and thus, hamper the government’s ability to collect taxes. As Rosenberg writes, “The adjustment will be painful for Europe in general, slicing off about 1% GDP growth annually over the next three years, and very painful for the PIIGS specifically. If these countries’ fiscal ratios were to return to 3%, Ireland would see four percentage points (ppts) shaved off nominal GDP annually over the next three years, Greece 3.5ppts, Spain 2.8ppts, Portugal 2.2ppts and Italy 0.8ppt.” So moral of the story is cutting expenditure and debt, won’t be easy.”

“Any more scares left?” she asked.

“To keep the debt at its current level, it will cost an average Greek citizen $2,500. Now that’s around 8.3% of the $30,000 that an average Greek citizen makes. The government can get this money by increasing taxes or cutting expenditure. Neither move will not go down well politically. Already, people are rioting on the streets of Athens, the capital of Greece,” I said, gulping the last few drops of nimbu paani.

“And what else?”

“Well all these problems could have been avoided, if people in the West had heard this Javed Akhtar couplet: “Sab ka khushi se faasla ek kadam hai, har ghar mein bas ek hi kamra kam hai.””
 

(The example is  hypothetical)

References:
Gold Investing: Protection Against Inflation,
Bill Bonner, May 12, 2010, www.dailyreckoning.com
David Rosenberg — Market and Data Musings, https://ems.gluskinsheff.net/
Greek Wildfire Engulfs the Euro in Flames, Buoys Gold, Gary Dorsch, May 13,2010, www.safehaven.com
Quiver - Poems and Ghazals, Javed Akhtar, Penguin