Evercore Pan Asset

Greece effectively went bankrupt last Spring, if bankruptcy is the inability to raise all the money in tax or borrow the money you need to sustain your expenditures from commercial banks and bondholders. The country was unable to borrow in the normal way from the markets and banks. The government negotiated a special deal to borrow money well below market rates from the IMF and Euroland countries, on the basis that the following year it would be able to borrow again in the markets at affordable rates. The Greek government imposed a programme of tax increases, spending reductions and privatisation sales to impress the markets and to pull it back from disaster.
 
Unfortunately the programme to cut the deficit did not work as planned. The markets remain unimpressed by progress so far. Far from warming to Greece, in recent months banks and bond markets have made it clear they do not wish to lend to Greece at any normal interest rate. As a result the IMF has threatened to withhold the next payment to Greece under its agreed loan, as the IMF only lends if the country concerned has access to the money it needs to pay its bills for the whole of the following year.
 
We are witnessing some cliff edge negotiations over how Greece will pay the bills after the expiry of the first IMF/EU bail out. The lenders are insisting on further measures to raise taxes, cut spending and sell assets. The IMF is also seeking a reassurance that enough EU countries will be prepared to lend again to Greece, as few think the deficit reduction programme will be so successful that Greece will soon be back borrowing in the normal way at sustainable rates. The danger of more tax increases and spending cuts when you cannot devalue is a further fall in demand and a further knock to tax revenues as output and incomes decline.
 
It has been clear for a long time  that the decision to let so many countries into the Euro before they met the exchange rate, deficit and debt requirements was big mistake likely to cause considerable economic pain as the strains started to show. Some now argue that Greece should decouple and devalue, re-creating the drachma and pricing herself back into work. Supporters of the wider Euro are worried of the consequences of any such move. They point out that people would seek to take their Euros out of Greek banks before the compulsory conversion, causing a run on the banks.  Doubtless there has been some flight already. Some have suggested that Y denominated Euro notes, those originating from Greece, might be suspect if removal from the currency area is in question, whilst others say it would not work like that as Greek Euro notes circulate freely in countries that have no problem staying in the currency zone and they would be honoured. Some market commentators worry about the French and German banks which have substantial assets in Greece, and favour another bail out to protect the bondholders owning Greek debt.
 
The truth is no-one can be sure what might happen next, as no-one is in charge and events can develop their own momentum. All you can conclude is there are substantial risks in Euro based investment, and we cannot see the end of this crisis for a while. There are better investment opportunities in the faster growing areas of the world. Lending more money to Greece for next year puts off difficult decisions for a bit longer but will not solve the underlying problems. If Greece is to stay in the Euro as European governments wish the country has to be financed more from the rest of Euroland. The current economic model is not working for Greece, and the new government will find it difficult to sell the austerity programmes required as the price of continuing EU and IMF support. It means more misery for Greece, and slower growth for the rest of Europe. Weak banks may lose more money over this crisis, which in turn impairs their ability to finance a vigorous recovery.

 As published in Investment Week