Jean-Claude Trichet, European Central Bank president, noted when speaking in Cambridge last Thurdsay that the speed at which financial disruption can spread had “accelerated tremendously over the past few decades”. While debt crises in the 1980s occurred over years, the effects of the Lehman collapse “spread around the world in the course of half-days”.

As Ralph Atkins pointed out, the Greek government is but the latest to learn that in the modern world you can be catapulted from relative obscurity to global prominence in a matter of hours. Everyone can be famous for five minutes, as Andy Warhol said, but this kind of fame most of us could well live without.

Faced with the assessment by Ratings Agency Standard and Poor’s that Spain’s economic and financial situation was deteriorating, the Spanish Prime Minister Jose Luis Rodriguez Zapatero simply limited himself to an outright rejection of such negative economic forecasts, declaring the naysayers to be wrong in the light of the -to him – self-evident fact that Spain was just about, at this very moment, to emerge from the recession which has now bedevilled it for so many months. Indeed he even went as far as to say they were wrong, since he he could find no reason why Standard & Poor’s should downgrade Spain’s long-term sovereign debt rating, “From our perspective there are no reasons for it, firstly because of the strength of the country (and) because the public accounts are solvent,” he told the Onda Cero radio station. Standard and Poor’s in fact argued that “The downgrade … reflects our expectations that public finances will suffer in tandem with the expected decline in Spain’s growth prospects”, a viewpoint with which few external observers would disagree.

Indeed, Spain’s representative on the ECB governing council Jose Manuel Gonzalez-Paramo told the Spanish press agency EFE, in an interview widely quoted in Spanish media, that he, himself, found the S&P opinion hard to disagree with: “The ECB is not taking issue with whether Standard & Poor’s should cut Spain’s rating, but the report that accompanies this warning is hard to deny….I’m convinced that Spanish authorities share this analysis and will do whatever is needed to avoid S&P’s negative outlook resulting in a change in rating,” he said.

Had Mr Zapatero found it within his repertoire to be able to express similar sentiments I am sure he would have done more to convince the world at large that he is aware of the problem, and is willing to take the necessary action. As it is, he simply leaves the impression that what just happened in Greece will eventually and inevitably happen in Spain, with all the suddenness and lightning-strike velocity M Trichet was warning about. What we seem to be facing is what Gabriel Garcia Marquez once called the Chronicle of a Death Foretold.

So what do the rest of us do, simply sit back and watch that “accident waiting to happen” actually happen? Angela Merkel may have other thoughts, since speaking in Bonn last Thursday she indicated that she, at least, was of the opinion pressure could be brought to bear on the national parliaments of countries with looming budgetary difficulties.

“If, for example, there are problems with the Stability and Growth Pact in one country and it can only be solved by having social reforms carried out in this country, then of course the question arises, what influence does Europe have on national parliaments to see to it that Europe is not stopped…..This is going to be a very difficult task because of course national parliaments certainly don’t wish to be told what to do. We must be aware of such problems in the next few years.”

Well, if such pressure can be brought it most certainly now should be. And not over the next few years, but rather, if M Trichet is to be believed, during the coming weeks and months. Lightning may well not strike twice in the same place, but it most certainly can strike twice.

In the long run we are all dead. But as someone else famously put it: we ain’t dead yet, and in the space between these two undeniable truths move forex traders, financial markets and a host of other would be economic participants. The financial press is full right now of headline catching stories about how Greece is at imminent risk of sovereign default. The German newspaper Die Welt even had a lengthy piece this weekend with the catchy title After Dubai, Who Will Be Next (the answer is obvious isn’t, otherwise what is the point of the question). One has the impression of a Europe filled to the brim with financial journalists busily rumaging the entrails, in search of the least glimmer of light which will confirm that something decisive and earthshattering might actually happen (soon), what with the German Der Spiegel announcing at the weekend that Greece’s growing public deficit problem is to be an item on the agenda at the next Governing Council meeting of the European Central Bank on December 17 (surely the big news would be if it wasn’t going to be there), and Bloomberg’s Maria Petrakis telling us that Greek Prime Minister George Papandreou is toiling away in what many might consider was a vain attempt to “convince investors he can tackle the worst fiscal crisis in 15 years”.

To add even more theatricality to the “drama” groups of protestors predictably battled it out with police on Athen’s streets, in marches that were ostensibly to commenorate the death of a young teenager in last years riots. Even the normally staid and prudent Economist throws its weight in behind the charge with a piece whose title tells it all: “Default Lines” (perhaps the words “in the sand” could have been thrown in to add a bit more tension), which goes so far as to suggest that a partial Greek default might even be welcomed by some Eurozone member states, since it might take some of the heat off a hard pressed euro.

As if to add a little more spice to the story, Standard and Poor’s decided to pick this Monday to announce it was putting Greece’s A- long-term sovereign credit rating on Credit Watch with negative implications, with the unusual little “extra” that it gave the Greek government only 60 days, as opposed to the customary 90, to respond with adequate information to avoid the decision of downgrading to BBB+ (a level which if it was generalised across the rating agencies would imply that Greek Bonds would no longer be eligible as collateral at the ECB once the temporary relaxation of normal criteria which accompanies the extraordinary liqidity measures is withdrawn – although who really knows when this is likely to be). Naturally bondholders were not slow in reacting to the news and the spread on the 10-year Greek/German bond yield widened again, to 201 basis points from the 174 basis points level of late last Friday.

Actually, this is far from the first time that investors and journalists have been getting excited about the default risk on Greek public debt. In fact that very same Spiegel had an article headlined Greece Teeters on the Brink of Bankruptcy as far back as last April (that’s a hell of a lot of “teetering” that has been going on), while the ever interesting Willem Buiter had a lengthy and influential blog post back in January on the worthy topic of whether or not it was structurally possible for a member state to default on its sovereign debt and remain in the eurozone (his conclusion was that it was, and in fact I don’t disagree with him).

But gentlemen are we not getting rather ahead of ourselves. As I said at the start, in the long run Greek Sovereign debt may be dead than the deadest of ducks, but it ain’t dead yet, nor is it likely to be in the most immediate future, there is far too much at stake for all of us for this to simply be allowed to happen, “sin mas”. In fact it was the much more cautious Moody’s who made the relevant points here in a press release issued last Wednesday where it argued forcefully that investors’ fears that the Greek government may be exposed to a liquidity crisis in the short term are totally misplaced.

Now words here do matter, Moody’s are completely right, the Greek government will not be exposed to a liquidity crisis in the short term (as opposed to a sabre rattling threat of one from the ECB among others), but this does not mean that they do not face a solvency issue in the longer term. That is, in the longer term I am absolutely sure that Greek public finances are deader than that proverbial dodo, the thing is, the long run simply hasn’t arrived yet.

Let Moody’s talk, since they do talk sense in this case:

“the risk that the Greek government cannot roll over its existing debt or finance its deficit over the next few years is not materially different from that faced by several other euro area member states”.

So here’s the first point, the Greek situation is a bad one, but it is not “materially different” from that of a number of other eurozone member states (I will return to this) even if the risk of its losing sovereign bond collateral eligibility is greater than that of any other member state, at this point. In the second place what Greece is inevitably facing is not a liquidity crisis (I’m sorry Maria, no financial crisis at this point), but a long term solvency one if it can’t raise its trend growth rate in the context of the looming cost of maintaining an ever larger dependent population with a declining and ageing workforce. That is to say, the strategic problem for Greek public finance is not the quantity of debt accumulated to date, but rather the impending dead weight of future liabilities, and how these can be met. In this case, short term technical default to wipe the slate partially clean and start-up again would resolve nothing, since without a much higher underlying growth rate (without the aid of government deficit funding) the impending liabilites are not supportable, and decision takers at Ecofin and the ECB know this perfectly well, which is why they may well rattle the sabres, but in the short term at least we will see little in the way of exemplary action. For a sovereign default in Greece (a mature developed economy) would be a complete first, and would take us all into very new, and uncertain territory, since it could quite literally become a default from which there was no viable route for return.

So What Is The ECB Up To?

The FT’s Frank Atkins has confessed to having been struck by the comments on Greece made by Jean-Claude Trichet, European Central Bank president, at the press conference which followed last weeks ECB rate setting meeting. I am sure he was not the only one who was listening, and given food for thought.

When asked about the country’s acute fiscal difficulties and the risk of a possible default, M Trichet simply stated he had every “confidence that the government of Greece will take the appropriate decisions”. This remark, as Frank Atkins says, was notable for its lack of forecfulness and could suggest he does not entirely rule out Greece facing sufficient problems servicing its debt that it might be forced into the hands of an external agency like the International Monetary Fund.

Indeed M Trichet’s statement could be interpreted as meaning that an exasperated ECB would almost welcome such an eventuality, and might by withdrawing easy short term funding from Greek Banks even give things a hefty shove in the direction of just such an outcome. But an ECB which does not frown on the possibility of their most recalcitrant pupil being steered briskly towards the welcoming arms of the IMF is not the same thing as an ECB which envisaging, contemplating, or even in its wildest dreams vaguely imagining a Greek sovereign default. Any suchbdefault would surely follow, and not precede a (flawed and failed) IMF intervention, or would be the inevitable by prooduct of Greece being unceremoniously ejected from the Eurozone by sheer market forces, with the ECB relegated to meer spectator, unable despite its best efforts to contain the situation.

So my reading of the situation as it stands now, is that policymakers will do all that is in the power (which is a lot) to avoid the markets having so much say in the matter, but that what they do want to do is keep up the pressure on the new Socialist administration in Athens. Their aim is surely to try to turn back the “moral hazard” screw whereby European Union authorities, in giving the impression that they will always and ever ride to the rescue, no matter what the provocation (and Greek statistical authorities sure have been doing some provoking), simply encourage member state governments to continue to act recklessly. And this becomes all the more important given the fact, as I mentioned earlier, that Greece is only one among several problem pupils, and that more than the credibility of the Greek government (of which surely there is little left), what is being tested is the credibility of the European Union’s institutional structure.

We might be forgiven for getting the impression that to date rather than acting as a stimulus to deep economic reform, Euro membership has rather acted to reward those countries who would get into more and more debt, with ever less sustainable economic models, by supplying them with funding at far cheaper rates of interest than the markets would otherwise make available. It is this particular clockhand that Europe’s leaders would now dearly like to turn backwards, and this is why I have little doubt that it is in Greece that a stand will now be taken. If not, then that longest of long runs may arrive rather sooner than some of us, at least, are comfortable with.

Despite recent optimism about the apparent renaisance of growth in the Japanese economy, and the heightened sense of enthusiasm which surrounds the surge in economic activity right across the Asian continent there are considerable grounds for caution about the sustainability of the Japanese recovery itself.

The first of these is to be found in the fact that, as has becomeplain from the latest batch of data releases, Japanese manufacturers are continuing to curb both capital spending, salaries and workforces, making any recovery in domestic demand driven by “second round” effects extremely unlikely. A second reason for having second thoughts is the long term decline in the level of Japan’s trend growth, which has fallen substantially over the last two decades under the impact of its shrinking and ageing workforce. Thus whatever the initial rebound, without the aid of strong demand elsewhere it is completely unrealistic to anticipate strong sustained growth in the Japanese case. And lastly it is evident that whatever the recent optimism Japan’s economy still faces major challenges, and in particular the risk of getting caught in yet another deflationary spiral, a danger which was recently highlighted by the announcement that prices fell at the fastet rate in half a century in October. Continue reading →