STICK TO THE EURO, NOT THE GYROThe Troika is a reference to the International Monetary Fund (IMF), European Central Bank (ECB) and the European Commission (EC). The troika is the economic powerhouse in charge of the bailout funds for southern European nations. They are not a well liked group by citizens in these desperate countries because they control the purse strings to badly needed funding but dispense it conditional to invoking painful austerity measures. To be clear, for the most part, austerity measures means laying off government workers and raising taxes. This effectively decreases bloated government spending and, in the case of Greece, has managed to yield a budget surplus.
Greece turned to ECB head Mario Darghi last month for the next round of bailout money to help pay down $12.8 billion in Greek bonds that mature in May and surprisingly, return to the financial markets with a bond issuance later this year. Although they were unable to accept any further austerity, the ECB was delighted that Greece managed their finances well enough to pull off a primary budget surplus of $1.5 billion. Also, Greece experienced slight relief in declining GDP from the troika’s forecast of -4.0% to shrinking at a slightly less rate of -3.7%.
Even more surprising than a budget surplus in a country of notorious profligacy was the announcement by Russian gas company Gazprom, that they would cut natural gas prices by 15% and backdate it to July. For Greek consumers this comes as a decrease of about 12% for natural gas.
There remain several looming specters, one of which is recapitalization of Greece’s four largest banks. The banks estimate they need $6 billion in fresh capital to remain solvent. However, the IMF stress test came up with a very different figure of $20 billion.
Another specter of Greece is Alexis Tsipras, the radical political leader who staunchly believes Greece should forego any bailout, exit the Euro and launch a new drachma. Fortunately, Mr. Tsipras trails in the polls but his mere existence is referential to an ideology rout with misunderstanding of economics.
To put it simply, if Greece left the Euro, there would be a run on the banks because as the drachma was reinstated its value would collapse upon lack of economic prosperity (negative GDP growth). You cannot simply create a new currency in an economy that is contracting and expect it to hold its value. As people scurry to hold on to what Euros they have, banks would have to freeze their savings leading to a credit crisis. This could cause contagion of non-southern European countries who have lent heavily to Greece such as France and the UK. Implementing a currency whose value is less than the currency from which a country was previously makes it significantly harder to pay debts fixed in nominal terms of the Euro.
Ultimately, it does seem increasingly likely Mr. Draghi will turn to Angela Merkel and her finance minister Wolfang Schauble to once again discuss the Eurobond, a form of mutualized debt for the currency union. This may be the only way to put an end to the woes of Greece, Italy, Spain and Portugal, but Germans are not keen on the idea of paying for their less ascetic neighbors.