GREED AND FEAR

The predictable EU/IMF joint €110bn package for Greece has not led to the short-covering trade that GREED & fear had expected. The euro bounced a little late last week but has sincecollapsed, while spreads have widened since Tuesday after narrowing somewhat in recent days.Thus, the euro rose from US$1.32/€ on 28 April to US$1.33/€ on Friday and has since fallen toa 14-month low of 1.28/€ (see Figure 1). Similarly, the PIIGS spread fell from 282bps on 28April to 229bps on Monday and has since risen to 321bps (see Figure 2). Such market action isnot impressive given the time, or at least benign interlude, that the announced €110bn shouldbuy.The lack of a more positive response reflects surely the market’s realisation that this is only thebeginning, not the end, of the deflationary dynamic caused by Euroland’s incompatible mix ofmonetary union without political union. There are also the uncertainties caused by the potentialfor massive strikes in Greece as will by the issue of whether Germany or other countries’legislatures will actually pass the agreement. There is also the position of Germany’sIt is true that the deal commits Greece on paper at least to real austerity while the economicprojections seem more realistic. Thus, under the deal, Greece plans to cut the fiscal deficit from13.6% of GDP last year to 8.1% this year and to 2.6% in 2014 (see Figure 3). While Greek realGDP is projected to decline by 4% this year and by 2.6% in 2011 (see Figure 4). It is also truethat the only way a socialist government has a chance of persuading private-sector Greeks topay their taxes is via a radical reform of the public sector. This is now part of the IMF conditions. Still GREED & fear remains of the view that Greece would be better off opting for a return to the drachma and debt restructuring in line with the sort of classic IMF programme implemented in countless emerging market restructurings before; most particularly as foreigners own about 70% of Greek government debt. Imagine, for example, the boom in Greek tourism that would follow a big devaluation.

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