Running for cover

Trouble looming, potentially, with Greece’s use of currency swaps to cover up its debt:

European Union leaders last week ordered Greece to get its deficit under control and vowed “determined” action to staunch the worst crisis in the euro’s 11-year history. Standard & Poor’s and Fitch Ratings are questioning Greece over its use of the swap agreements, said two people with direct knowledge of the situation, who declined to be identified because the talks are private.

“Greece used accounting tricks to hide its deficit and this is a huge problem,” Wolfgang Gerke, president of the Bavarian Center of Finance in Munich and Honorary Professor at the European Business School, said in an interview. “The rating agencies are doing the right thing, but it may be too little too late. The EU slept through this.”

And its not just Goldman Sachs, currently close advisors to the Greek government, that are now under scrutiny for arranging the swaps. Like kicking over a log, the Greek crisis has brought all sorts of wriggling creatures into the light of day.

No money, but plenty of fudge

I honestly expected that they would come up with something a little more solid than this:

Following talks between the Greek prime minister, George Papandreou, Merkel, President Nicolas Sarkozy of France, and Jose Manuel Barroso and Herman Van Rompuy, the European commission and European council presidents, the leaders issued a statement aimed at restoring calm and voicing political support for Papandreou’s programme of swingeing budget cuts and structural reforms.

The statement said the 16 EU countries who use the single currency, including Greece, “will take determined and co-ordinated action, if needed, to safeguard financial stability in the euro area as a whole.” That was seen as a strong political signal to speculators that the big euro economies such as Germany and France would act persuasively to restore confidence in the currency.

But there were no promises of funds for Greece and the statement emphasised that “the Greek government has not requested any financial support”.

The crisis has exposed the weakness at the heart of the Euro project: monetary union without fiscal and political union lacks credibility. Some in the European institutions want to exploit the current chaos to push Europe towards the latter two (see monetary affairs commissioner Oli Rehn’s comments on “surveillance”) but if the major powers can’t get the Euro through this difficulty in good shape, that’s not a likely prospect.

A bailout would be expensive. The more fervent believers in the free market’s virtues worry, too, about the bad precedent it could set for other afflicted states. But this verbal fudge carries its own risks: presumably, the expectation is that “oversight” from assorted international bodies would be enough to force the Greek government to get its house in order to the satisfaction of the markets.

That will mean cracking down and breaking the protest movement domestically. At present, Papendreou’s new administration appears to have persuaded a fair chunk of its population that, to use David Cameron’s charmless phrase, the cupboard is bare. On the other side, the strikes, blockades, and demonstrations continue. The battle lines could not be drawn more sharply.

Institutional vultures

The Financial Times, on the IMF sniffing around the EU’s debt crisis:

Few doubt the IMF would jump at the chance to be part of any rescue mission, though officials are careful to say the decision is up to Greece. But the extra cash and credibility that the IMF would bring has to be weighed against the negative signal conveyed by calling it in at all.

During the past year, the IMF has come off the sidelines to take a central role in the attempt to rescue central and eastern European countries from financial crisis. It has often been steering rather than rowing – devising and monitoring the conditions that borrower governments have to meet to qualify for money without necessarily providing all that finance itself.

For the time being it looks as though Germany and France are making enough soothing noises to calm the markets without assistance. Even if they weren’t Greece’s two biggest foreign lenders, with German and French banks between them holding around one-third of Greece’s debt, both would recognise the dangers to the entire EU project of an undignified Greek exit from the Euro, never mind a default. A rescue package would have to be found.

But having the Washington-based IMF step in to clean up a European mess would be hugely damaging. That’s why both leading EU economies are so keen to given the impression of self-sufficient competence. It’s working, for the time being.

There are shades, in all this, of the still-born Asian Monetary Fund (PDF). In the midst of the East Asian currency crisis, late 1997, the Japanese government proposed establishing a regional fund that could bail out financially-stricken countries. They argued it would be better-placed to respond to regional crises than an international institution like the IMF.

Needless to say, Washington was less than thrilled by the prospect, seeing it as a major challenge to its own financial hegemony, and the idea was swiftly nixed.

The EU represents less of an obvious challenge than an upstart new pretender: it’s a long-established institution, and the Euro itself has been around for a decade. But if a credible Europe-wide rescue package can be cobbled together, independent of Washington, it’ll be a further blow to the IMF’s battered authority.

Meanwhile, the Chiang Mai Initiative – a potential forerunner to a broader Asian Monetary Fund – is up and running. And the Latin American Banco del Sur is now established. Behind the current panic lies a gradual slide in the US’ economic power in the world.

European contagion

It took them a surprisingly long time to move, but as of this morning the speculators have seriously latched onto the Euro:

Traders and hedge funds have bet nearly $8bn (€5.9bn) against the euro, amassing the biggest ever short position in the single currency on fears of a eurozone debt crisis.

As the FT suggests, they’re betting on both the Greek government’s inability to avoid default – or at least devaluation and exit from the Euro – and the subsequent inability of other Euro currencies to withstand ‘contagion’: financial instability spreading from one economy to the next, with country after country pulled into the maelstrom.

Other Euro economies are exposed to Greek upsets through the substantial investments various European financial institutions now hold there. French investors are the biggest, holding $58bn worth of Greek debt at the end of 2008 (on the IMF’s most recent figures), with German investors next on $32.3bn.

UK holdings are more modest, but still very substantial, covering $14.4bn worth of loans. Around a third of Greek government debt, meanwhile, is held by Greek investors. All will take a hit from substantial fiscal turmoil in Greece. And all the big exposures are in Europe.

Major financial institutions can try to get rid of some of this risk by adjusting their portfolio of assets. The real danger is that, in doing so, they will look to dispose of debt securities held in other, smaller Euro economies with weak fiscal positions – Portugal, Ireland and Spain, in particular.

It’s these three that are now causing additional grief for the Euro. A quick glance at the combination of high public debt, and wobbly governments, tells you why the short-sellers are licking their chops. The betting is on one of the PIGS, so-called – Portugal, Ireland, Greece, Spain – going belly-up some time soon.

But it’s Greece that remains the biggest single risk. Revisions to the public debt figures have rattled markets, while the deep spending cuts offered in sacrifice by the newly-elected PASOK government have failed to calm jangled nerves.

If the big banks and the institutional investors pull out of Greece, they can spread financial instability elsewhere – with speculators adding to the chaos, moving colossal volumes of hot money at fantastic speed across national borders. The whole Eurozone – potentially even the Euro project itself – could suddenly appear unstable.

The decade has been generous to the Euro. A benign economic environment, floating atop a giant property-and-finance bubble, kept the show on the road. Those days are long gone.

The deciding factor here, however, is political. Either the Greek government can keep the markets reaonably sweet, holding firm to bigger and bigger promises attacks public services and wages; or the markets will be unconvinced, dragging Greece out of the Euro.

That’s where the EU steps in. The risks of contagion, and the damage to the Euro’s credibility, will no doubt concentrate European finance ministers minds on arranging a bailout. It’s the prospect of a rescue package, rather than some sudden belief in the Greek government’s firm grasp of the axe-handle, that has led to some improvement in the Euro’s position.

The planned cuts are already meeting resistance. Farmers are blockading roads, and thousands of public sector workers are expected to strike tomorrow against the wage freeze.

Serious opposition in Greece to the EU’s austerity package could open the path for resistance across Europe. But successfully fighting off the cuts will also mean building a credible, political opposition to the rule of finance.

(hat-tip to Eugenia for the figures)