The European Financial Stability Fund was established in order to provide the liquidity to countries in need, provided that they take drastic steps to recovery. Financial markets should therefore abandon all fear to lend to states and banks in the euro area. This is not what we observe. Is this an effect of a new maneuver speculative or is this a sign that Europe’s problems are not solved so far?

grcki euroThe second hypothesis is by far the most likely, to the point that a new banking crisis is possible. Mmany governing bodies in Europe have worked hard to establish a support fund, endowed with impressive response capabilities. European states are unlikely therefore more liquidity crisis. The problem is that they may rather insolvency.  What “saves” Greece? Officially, the idea is to provide liquidity to the Greek state to finance for three years, until the remedies are working. The underlying assumption is that the Greek situation can be rectified within three years. In that case, why fund managers expect their stratospheric interest rates to buy Greek debt?

The answer most often given is that financial markets are speculating against Greece and Europe in general and that this speculation is self-fulfilling. This response does not make sense, it is quite possible that the CDS accentuate the phenomena, but they do not explain the current difficulties of Greece to find buyers for its debt. Indeed, if the speculation was causing the problem, the price of CDS would be much higher than it is, corresponding to an anticipation of rising interest rates on Greek debt. Since this is not the case, consider another case, more simple, namely that operators do not believe the scenario of recovery in three years and take seriously the possibility of a default state Greek. A look at the available data, it is quite logical. The country’s public deficit for 2009 is estimated by Eurostat between 13.6 percent and 14.1 pervent of GDP, public debt is estimated at between 115 percent and 120 percent of GDP at end 2009.

The first solution is austerity. If the crisis is limited in scope, you can get away with borrowing to buy time and take austerity measures reducing balance. We have seen, this answer is not at the height of the Greek problem. The second solution is inflation, which reduces the real value of debt. But inflation does not assert itself, especially with an independent central bank. Logically, inflation can arise only if the output gap (difference between growth and full employment growth actually occurred) is positive. However, it is now negative and the austerity measures will increase it.

On the monetary side, the ECB already practices zero interest rates and the limited monetization of deficits that has been accompanied by a process equivalent sterilization by attracting additional deposits to her. This solution is currently unthinkable.  The third solution is to restructure the debt. Clearly, this is for the creditors and the Greek state to agree on some Greek debt discount, once accepted the idea that full repayment is impossible. For example, the government would commit to continue to pay interest on the debt and pay 50 € a bond with a face value of 100€.

While being the IMF, Anne Krueger, American economist had also proposed a mechanism similar to U.S. bankruptcy law to manage such situations. In Latin America in the 1990s, the Brady Plan, named after a minister of George Bush senior, has organized such a mechanism discount. The only alternative to a solution of this type would be a sudden collapse. The restructuring, which nobody wants to hear right now, then eventually win through, and this justifies the high interest rates on debt and Greek concerns about the profitability of banks.

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