Wednesday, May 05, 2010

Eurozone tottering (cont.)

Greece descended further into chaos today as demonstrations turned violent and deadly. Masses of protesters chanting, "Thieves! Thieves!" attempted to storm the parliament building and threw Molotov cocktails at police. Unsurprisingly yet tragically the first deaths also occurred as three bank employees died when demonstrators set fire to the bank building where they worked.

These episodes are making evident the one factor ignored in the financial and political calculations for saving Greece and the eurozone: namely, the verdict of the population at large. Greek labor leaders and others have figured out that the proposed “bailout” really only bails out the banks which foolishly gave Greece all the credit rope with which it has hung itself.

The bailout’s goal is to avoid a Greek default on its debt. In addition to billions of euros in new loans, this supposedly will be accomplished by drastic cutbacks in Greek living standards. Greek demonstrators are saying, “Sorry but we want everyone to share the pain.”

A restructuring of Greek debt is becoming increasingly likely, as market reactions are making clear. In other words, Greece’s creditors are going to take a hit. Alone this may not be such a big deal but the precedent it sets has bankers and the markets in a growing panic. The fear is that the rest of the PIIGS will quickly get in line for similar treatment and possibly other countries as well. Now we’re talking real pain for the banks which—despite the rosy claims of having “turned the corner”—are still in a precarious state.

Exposure of US banks to possible European defaults is not insignificant. In addition, such defaults would almost certainly mean a deepening of Europe’s recession and a devaluation of the euro. American exports would take a hit, further slowing or even reversing the US recovery. Despite such dire consequences, financial writer Simon Johnson says in a very pessimistic column that we should “expect nothing” in the way of genuinely constructive help from those in charge:

The Europeans will do nothing this week or for the foreseeable future. They have not planned for these events, they never gamed this scenario, and their decision-making structures are incapable of updating quickly enough. The incompetence at the level of top European institutions is profound and complete; do not let anyone fool you otherwise….

The Europeans will not lift a constructive finger. The leading emerging markets are too busy battening down the hatches (and accumulating ever more massive chests of reserves). And the White House still seems determined to sleep through this crisis. Expect nothing.

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