For the last 10 years, the Greeks, the Italians, the Spaniards or the Irish, have enjoyed a good time, spending much more than they afforded. For some of the countries of the 16-member euro currency zone — Greece, Ireland, Italy, Portugal and Spain, the prolonged dream of everlasting consumption has turned into a nightmare. The new reality has raised the probability of default and the risk that the country may be forced-out of Eurozone. Though the prospect is very unlikely, it has to be taken into account very seriously. Since the beginning of the month, when massive problems have emerged within the EU-16, the EUR currency has dropped significantly against the USD, from a level of 1.51 to a level of almost 1.43. According to FX data, the value of the dollar’s net short position fell to around $11.8 billion in the week ending December 13, from 21.8 billion the previous week.
For the most of the aforementioned countries, joining the Eurozone was a point of pride, showing that they managed to keep their budget deficits under control. Today, in the middle of the worst economic downturn since the euro currency’s inception, many issues are emerging, as the creditworthiness of Greece, Spain and Portugal has been downgraded. While Greece or other EU-16 countries may have been insulated from the currency risk, there is always the credit risk associated with the collapse of confidence in its solvency to be accounted for.
Since the beginning of the financial crisis, Germany and France have developed expensive economic stimulus plans and bold measures to protect their banking system. With a similar need for stimulus, the peripheral economies find themselves in an awful situation: not only the credit is available at very expensive rates but also does the additional borrowing raise more questions about their solvency. Consequently, bond traders are punishing the sovereign debt issued by countries with dubious economic prospects. As a matter of fact, yields are skyrocketing on the debt of peripheral European economies with growing deficits. The widening gap between the interest rate that Greece and Germany have to pay to borrow – currently at 250 basis points, reveals the first signs of malfunction in the EU system. Once the first domino piece falls, then it will be a matter of time until Eurozone will disintegrate.
Today, Standard & Poor’s downgraded Greek debt to BBB+, one week after Fitch has downgraded Greece to the lowest credit rating in the Eurozone. The government has promised spending cuts, tax hikes, a crackdown on tax evasion, such that in 2010 they would have to borrow around EUR52 billion. That would be a large drop from the EUR66 billion the country has borrowed this year. According to Vassilis Karatzas – a fund manager in Athens, “There is fear about the Eurozone, but the EC will not allow its periphery to go down. United we rise, divided we fall.” Stefanos Manos – a former economic minister agreed that Greece has to stop running deficits. He said “We need money to finance our deficits and I see difficulty in us attracting such funds from abroad.” As for the rest of Europe, particularly its weaker economies, he added “I don’t think Europe is up to it since it expanded too rapidly without fixing its institutions first.”
If for whatever reasons, a country decided solely to leave the Eurozone, vast disruption would result and the replacement old currency would be categorically weak, reflecting investors’ perception that the country was uncompetitive. Therefore, the only viable possibility of an economic breakdown followed by the Eurozone breakup would have to originate in Brussels. In any event, the probability of EU-16 breakdown is nowhere near zero.
“EU – On The Verge Of Breakdown”: I would have been millionaire if I would had get €1 each time I’ve heard this. Your analysis is uni-dimensional, only about the common currency. There are many other perspectives to the issue. There are economic synergies in EU that goes beyond the common currency. The ERM2 (Euro’s precursor) failed in early 90′s and this did not derailed a bit the EU economical and political integration process. If I recall well, before the Euro creation, no one single member-state met the convergence criteria, and again this did not derailed the EC/EU a bit.
Greece is not a major Euro-zone economy, this will lower the “cost of treatment”. Yes, a country may leave Euro-zone, more others will join it. So? As long as the core engine (France, Deutschland) works, the confidence of the financial markets in Euro will be there, and the EU project will continue to exist. Without Euro, Greece will be in the same difficult situation, since their problem is not monetary, but of basics financial responsibility (of its citizens, of its businesses, and of its government). There are hard time for Greeks ahead, but that’s about it.
A smaller short-term Euro depreciation will help further EU’s exports, too, as EU relies so much on exports due to the heavy taxation needed to fund the generous welfare system. I recall statements from large German firms recently about the Euro being “too strong”.
I think that your analysis is correct, but from a simple model or looking at things is jumps too quickly to titles way too bold. That is to say that you venture too quickly to shout “Earthquake!” when its just a crack in the wall of an old peripheral building. Personally I’ve would expect more caution in drawing conclusions form someone who’ve managed (financial) risk. You may need to remember that unlike the Anglo-Saxons style of UK and US (your area or expertise), the proper EU is less about bold moves and statements, and more about getting things slowly but surely. Thank you.
Radu,
The title is all about the EUR currency. Frankly speaking I have nothing against Europe as a federal entity.
However, the EUR does not make sense for several reasons. On one side, there is a common monetary policy. On the other side there are 16 different fiscal policies: one for each member state. This system cannot work forever without glitches. When economies are growing everything is fine and rosy. When the crisis hits the fan, then you have a hell of a problem. Greece is not the only big problem in EU16. The EC forecasts budget deficits for 2009 of 11% in Ireland, 6.2% in Spain, 5.4% in France and 4.6% in Portugal. As you can see, The picture is quite gloomy. I am not going into other details, but EU has a long list of issues that could lead to EUR currency breakdown. All it takes is a single country leaving the Eurozone. Then you have the snowball effect. At the end of the day, it’s all a political game and less of a well thought out economic system. And you should know that.
Toni,
My economics understanding is pretty basic but I’m wondering why nowadays with the strengthen of the RON, what are the reasons behind the following statements from all kind of talking heads: “a powerful RON is not good for the economy” … “a strong RON may be bad”.
I don’t get it … when it was 4.3 it was bad when now it’s 4.1 and maybe going for the <4, it is again bad.
Why is a strong RON bad ? (except for the exporters)
- Romania is definitely not an export led economy
- I'm paying less for my phone bill
- My rate for the credit that I have, is actually cheaper
- all the other goods that I'm buying (electronics, clothes etc etc) that are imported, should get cheaper
- etc
Therefore, why would BNR "temper" the market as Barclay's said ?
Thank you and I hope it was not such a "beginners question"
Dan
Daniel,
Don’t worry. Your understanding makes plenty of sense. Do not pay attention on the so-called “analysts”. If you want to have some fun, read my old article “Three Strikes – A Strikeout”. The same old story with these guys publishing about the RON FX Perspectives.
Fair and square: a strong RON is GOOD for the economy. Not even exporters are much worse-off with a stronger RON. Generally, the price elasticity is not that strong with the currency. Do not forget that FX is up–and-down variable. There are months when FX is making your profits look stronger and months when your profits look weaker.
Not to mention, exporters have the option to get into FX hedging by simply calling the friendly banks for some sweet quotes.
Other than that, a strong RON is good for everybody, especially for BNR’s battle with inflation.
Toni,
Thank you for the detailed reply. It looks like my basic knowledge of economics is not that bad when “applied” with common sense. I’m glad also that I found other “interesting” things from the posts below that followed.
I still have some questions:
1) Why is more costly to have a credit (in Eur) in Romania than in other EU countries ? (for example Austria where I checked personally: better terms and better rates)
2) Could you please explain a bit more how a strong RON is good “especially for BNR’s battle with inflation”.
3) Off-topic: Are you the only romanian who ever worked on Wall Street?
Thank you and have a great weekend,
Daniel
Daniel,
I would start with the 3rd point: I am DEFINITELY NOT the only romanian who ever worked on Wall Street. One thing I could claim: there are more fellow countrymen today on WS then I had found when I started back in 1998.
First question should be obvious: theoretically a EUR credit should be cheaper in EU than one in RO for two reasons: a) the market is more mature and b) the EUR funding for EU banks is tha same or better than their RO counterparts.
A stronger RON is the strongest weapon against importing inflation.
Toni,
Thanks for the info’.
Regarding the 3rd point, I will take that as a positive thing. However, my next suspicion is that, I guess NONE of them had their education done exclusively in Romania, right ?
Daniel
Daniel,
Most of them hold an undergraduate degree from RO and a graduate degree from US. The same goes for me, too. I assume it is harder to get inside the system without a degree from a top school.
Toni,
Without the need to give some names, more than sure, the talking heads in discussion are the ones who were/are still long on Euro/Ron “going” for 4.5 or 5 … then it is obvious that they appear on tmctv with “A strong RON is not good for the economy” which translated becomes “A strong RON is going against my position on FX”
I’m not sure what’s the case outside RO, but when they appear on TV they state “the research department is separate … we don’t know the bank’s position” … I really don’t buy that …
How is it really Toni ?
Bogdan
Bogdan,
You are perfectly spot on. It is exactly like owning a million shares of Fannie Mae (cost basis $80) and claiming on CNBC that FNM is the greatest company Wall Street has ever seen; when in fact FNM is a pure POS.
At the end of the day everybody is entitled to his or her opinion. It is our job to separate between the trash and the real deal.
The disclaimer you talk about, shows-up on CNBC screen every time an analyst gives a public opinion on a particular stock.
Toni,
Digging in, just look at this video, right on the money … marvelous … 28 Oct 2009 http://www.money.ro/intern-1/cearta-in-direct-intre-bancheri-bogdan-baltazar-vs-nicolae-chidesciuc.html#video
Statements regarding the first part of the previous post:
“BNR nu are interes să lase un leu prea puternic”
“Una dintre cheile ieşirii României din recesiune este inclusiv stimularea exporturilor”
“BNR nu vrea ca leul sa se aprecieze prea mult din cauza ca ar afecta exporturile, care se vor a fi motorul revenirii economice din Romania” … Since we don’t export too much in comparsion with imports, how could this be a “key”/”engine” to … ?
“BNR schimbă inamicul: lupta se va da cu leul prea puternic” … this is a good one, at 4.1 the RON is too strong, we are gonna fight with it
“Leul prea greu” …
Bogdan
Bogdan,
Thank you for the video link. I do not know what to say. It is bitter and sweet at the same time. Sometimes, I smile thinking that I do not have to witness that circus.
I do not wish to be the referee, but the truth is somewhere closer to N. Chidesciuc than to B. Baltazar. Nothing is about their age; instead it is all about respect and what you know or what you don’t know. So, Mr. BB could claim anything about the ING and its economist, but unless he can prove something…it is worthless. Unfortunately, Mr. NC is a little rough on the edge and he was looking for conflict.
If I were the judge I would simply invite both to an intellectual bet on the EUR:RON with a “winner take all” approach.
Toni,
When you got the undergrad from RO it was still a reasonable undergrad. Now what you get (I strictly refer to economics Buc, Cj, Iasi or TM) is close to the worth of the paper on which is printed on, unfortunately.
Cicioc Bogdan
Bogdan,
I got the engineering degree from Poli in ’92 and the economics degree from Cibernetica in ’95 (both in Bucharest and both full-time).
My humble opinion is that the undergrad/grad education level in RO was far from where it should have been back then. However, these days it is a bad joke, and I hope I am not too harsh.
Toni,
The story is picking up. A note from a Societe Generale analyst is pointing exactly the same direction.
It looks like even bailing out Greece will only mean we postpone the pain. Maybe it will equal just buying some time.
Anyway, it’s really interesting how the story will develop.
Bogdan
Bogdan,
Theoretically, EUR is a nice concept. Nonetheless, it is very hard to make it work in the current bipolar economic system. The questions is: are the germans better-off with the old DEM?
Toni,
Let’s say euro will be fine etc and we have Romania in 201X ready to take the euro and NBR not having ~30Bn EUR like now but
20Bn or 15Bn EUR … in the period before taking the euro like 1-2 years, what will, should or basically the possibilities of NBR to managee all that EUR reserve ?
BogdanC
BogdanC,
Having a hefty reserve does not hurt you at all. It sends a very positive message to foreign investors. Nowadays, it seems that there is a probability that X is approaching infinite. If X <9, then the NBR reserve is money in the bank. I am shocked that NBR is not defending RON like they did in the past. By not doing that they open the gates to the inflation flood. Then the 6.25% benchmark rate looks like a very stupid decision.
Toni,
Thank you. What about if they will want a strong RON or a weak RON right before taking the euro ? + What do you think it should have been the 6.25% decision ?
BogdanC
BogdanC,
The same old story. There will be some strong support for an undervalued RON, and the reason is a better competitive advantage within the EU markets. BNR should raise rates as fast as they breath, since inflation is picking up.
Toni,
I see … what about now if The ECB failed to auction the €55bn in fixed term deposits it had planned to … do you think that Spain will fail to sell too its junk debt, excuse me AAA+ debt, this week ?
BogdanC,
It seems like they are plenty of investors willing to sign-up for hefty yields. If the principal is paid back, Spanish debt might prove to be not such a bad idea.
Toni,
I see … it proved there was no problem … I just saw GOLD and was wondering, what caused the sell-off ? Thank you
Toni,
Could you please answer why finally gold sold-off ? thx
BogdanC
BogdanC,
Gold tumbled the most since Feb ’10 on more positive news around the EU banking system stress test program. However, traders see this as another opportunity to get long.
Toni,
Do you think Greece will default after all ? I mean its public debt is expected to rise to nearly 150% of GDP by 2016 which is three times the level of Argentina when it defaulted in 2001 … it is just too much I guess …
BogdanC
BogdanC,
I said it before I say it again: the optimal solution for Greece is debt restructuring.
Toni,
I recall that but it seems this optimal is still being prolonged in time for all kind of reasons …
BogdanC,
When the apple is rotten inside, it does not matter how many times and how long you do polish it outside. One day, you will have to take a bite…and I don’t think it will taste that good.