In memory of Dr. Andreas Höfert

Greece is still not out of the woods, nor is the euro crisis finished

We are approaching the third anniversary of the onset of the Greek sovereign debt crisis, and by extension the beginning of the euro crisis. If we compare the situation today with that of a year or even six months ago, we can get the impression that things have improved. But is it really so? Or is it just another calm before the next storm?

Last June after the Greek elections, the results of which were much better than feared, I wrote an editorial entitled “Still not out of the woods.” One of my main points was that “Greece will not be able to comply with any austerity plan bringing it back on a stable debt trajectory if its current debt is not further reduced, i.e. without another default. Hence, we still see a high likelihood that Greece may be forced out of the Eurozone at a later stage, in 18 to 24 months.”

Though a second bailout package of 130 billion euros (atop the first one of 110 billion euros) was approved for Greece on 26 November, my June assessment of the situation remains one of my high conviction calls. A scenario in which Greece stays in the Eurozone without a second major haircut on its debt, this time involving official sector holders like the Eurozone countries and the ECB, becomes very unlikely in a 12-to-36-month time horizon.

Even under the latest agreement, Greece’s debt-to-GDP ratio will continue to rise, as will social unrest in the country, and make it that much more difficult for authorities there to comply with the unbearable austerity, if they ever really intended to do so.

Even German Chancellor Angela Merkel seems to have acknowledged that the situation remains unsustainable without a haircut. At least (and at last one is inclined to say), she alluded to the possibility, when interviewed last Sunday by the German tabloid Bild am Sonntag, of some kind of debt relief that public debt holders participate in being offered to Greece, but only if it achieves a significant primary surplus within the next three years. Given the fierce opposition to such a plan not only in Germany but in Finland, the Netherlands and other parts of Northern Europe, I don’t foresee a significant haircut being applied or, at least, one substantial enough to guarantee a sustainable debt path for Greece.

So the two likely scenarios over the longer run are:
1) a continuous muddling through marked by an insufficient public sector haircut; and
2) a managed, or unmanaged, Greek exit from the Eurozone. Our subjective probability of the second scenario occurring approaches 50% within a 12-to-36-month horizon, so we consider the results of the 26 November meeting just another attempt to kick the can down the road to stall for time until the German general election scheduled for September or October 2013 takes place.

British economic commentators like The Daily Telegraph’s Ambrose Evans-Pritchard or the Financial Times’ Wolfgang Münchau have stopped writing hysterical editorials forecasting the imminent end of the euro. This in itself is a relief. Currently, the euro crisis is on the backburner for market participants, who remain more worried about the looming US fiscal cliff. But it could return quickly to the forefront of market concern. What would happen, for example, if at some later stage the current Greek government lost a confidence vote in parliament and new elections needed to be called?

Greek mythology has plenty of examples of creatures considered dead suddenly coming back to life, as the euro crisis has done several times in the past three years. One thinks of the Phoenix rising from its ashes. However, the Lernaean Hydra, which grew two new heads for every one cut off, appears even more pertinent to our case. Hercules managed to kill it by cauterizing its severed neck with fire. In my view it will take a Herculean effort to put a definitive end to the crisis.