Strategies and Cheese

Emil A. Georgiev wrote a comment in my blog that I think entails a new post in reponse. He said:

I believe the Emirates will make it, but what do you think about Greece – a member of the Eurozone?

Yes, Greece’s budget deficit, rating downgrades and potential problems with their sovereign debt rollover are somewhat alarming. The problem is not that they do not have the money to repay that debt (of course they don’t) — the problem is that they are supposed to refinance themselves from the market. And as the market lends only to prudent borrowers, at a 12,6% deficit Greece may not be considered an eligible one.

Yet when it comes to a Western European, Eurozone country make no mistake — that debt will be underwritten no matter what. On the one hand, the effects of a potential Eurozone sovereign default will definitely be Lehman-like, i.e. the systemic relevance of that sovereign default is paramount. On the other hand, the surplus liquidity that the ECB seems to be slowly and deliberately retracting (e.g. their announcements on the ‘enhanced credit measures’ from last week) can and will be channeled elsewhere when needed. They do not even have to go great lengths to inflate away that debt.

In the end of the day, no one will allow a small and highly leveraged country of such systemic relevance to go under. Not only Greek’s government, but also the whole Euro currency union is only as good as its credibility. The rating agencies’ response and ultimately the higher cost of borrowing will have to be sadly borne by the whole Greek nation. Putting a higher price tag on future borrowing for the whole Greek economy out of rating/market necessity will act more disciplinary than any legal constraints Brussels might impose on Greece. After all, if they had been following the Eurozone 3% GDP deficit guidline figures, they wouldn’t be in the mess they are today. I do expect though that there will be significant pressure on Greece to cut its public spending, should the EU/ECB really step in to bail out the Hellenic Republic of Greece.

By the way, what this also re-translates to is that Bulgaria’s aspirations to ERM II could be put to a halt for the forseeable future. Joining the EU once is a good deed, but entering the monetary union now might actually go far beyond the official Maastricht criteria. Thus, even if we consider that in a semi-deflationary environment Bulgaria meets all three criteria with a balanced budget (close but under the 3% mark), low inflation (to be in the top 3 lowest EU-wide if I recall correctly; seems somewhat achievable now) and low public debt (Bulgaria’s is way below the maximum of 60% of GDP required), Bulgaria might still not make it to the Eurozone out of political and country risk reasons. Even without the infrastructure and social expenditures of Greece.

In a nutshell, Greece will not default. As the saying goes, if you do not repay a € 1.000,- debt you have a problem; if you do not replay a € 10 million debt, the bank has a problem. In this case this bank is the ECB and the responsible account manager is the EU. They will surely get a hold of the situation, yet the “little Dubai” effect and the bad aftertaste of a popped property price bubble will continue to linger not only on Bulgaria and Greece, but also on any country that leveraged itself mostly through property sales, rather than industrial output in the recent years (such as Spain).