>GREED & FEAR: The euro end game (CLSA)

Austin
The predictable EU/IMF joint €110bn package for Greece has not led to the short-covering trade that GREED & fear had expected. The euro bounced a little late last week but has since
collapsed, while spreads have widened since Tuesday after narrowing somewhat in recent days.
Thus, the euro rose from US$1.32/€ on 28 April to US$1.33/€ on Friday and has since fallen to
a 14-month low of 1.28/€ (see Figure 1). Similarly, the PIIGS spread fell from 282bps on 28
April to 229bps on Monday and has since risen to 321bps (see Figure 2). Such market action is
not impressive given the time, or at least benign interlude, that the announced €110bn should
buy.

The lack of a more positive response reflects surely the market’s realisation that this is only the
beginning, not the end, of the deflationary dynamic caused by Euroland’s incompatible mix of
monetary union without political union. There are also the uncertainties caused by the potential
for massive strikes in Greece as will by the issue of whether Germany or other countries’
legislatures will actually pass the agreement. There is also the position of Germany’s

It is true that the deal commits Greece on paper at least to real austerity while the economic
projections seem more realistic. Thus, under the deal, Greece plans to cut the fiscal deficit from
13.6% of GDP last year to 8.1% this year and to 2.6% in 2014 (see Figure 3). While Greek real
GDP is projected to decline by 4% this year and by 2.6% in 2011 (see Figure 4). It is also true
that the only way a socialist government has a chance of persuading private-sector Greeks to
pay their taxes is via a radical reform of the public sector. This is now part of the IMF conditions. Still GREED & fear remains of the view that Greece would be better off opting for a return to the drachma and debt restructuring in line with the sort of classic IMF programme implemented in countless emerging market restructurings before; most particularly as foreigners own about 70% of Greek government debt. Imagine, for example, the boom in Greek tourism that would follow a big devaluation.

To read the full report: GREED & FEAR