Leading Economist Roger Martin-Fagg provides his latest Economic Update . Vistage members can access the economic update in full via Vistage Village, please find below an excerpt.
This update will be out of date by the time you read it! Events are moving fast and we need to have a view on the risks and outcomes. So we must begin with the Eurozone.
In the March update I outlined the basic problem. To recap; Germany has pulled up the average level of productivity in the zone, but Clubmed has fallen further below the average. The consequence is large surpluses in the North (mostly Germany) and corresponding large deficits in the Clubmed. Rebalancing normally takes place through changes in relative prices brought about by either devaluation of the currency (or for high productivity systems, revaluation), or if that cannot happen, real wage cuts, or and this is most unlikely, a step change in productivity in the weaker players.
The Eurosystem has allowed Clubmed to enjoy real increases in their standard of living based mostly on credit, capital, and goods supply from the North. In particular Northern Banks were willing to purchase Clubmed bonds at high prices (low interest rates).
No longer. Reality has hit home.
There are four generic solutions to the imbalances.
1. A permanent and substantial transfer of resources from North to Clubmed
2. A 30% devaluation of the Euro to shift the whole area into a bigger surplus with the rest of the world
3. Weak growth in the North, deepening misery with significant real wage cuts in Clubmed and the rise of extreme politics.
4. A breakup of the system into more manageable parts.
Any student of history would advise option 4 is the only realistic and sustainable solution. I will explore it and suggest a timeline (which is likely to be wrong)
In the next 8 weeks Greece leaves the Euro and defaults. It will announce on a Friday at 4pm their time that all banks and flows to and from the country are closed. They will remain closed for two weeks. The existing stock of Euros within Greece will be over stamped with a big D. These will be exchangeable with other Euros at a rate of 1:1.5. Over three months the new Drachma will be introduced, and Euros converted at this fixed rate.
There will be a year of misery, an inflation rate of 20%, and social unrest. But when the Greek banks reopen there will a torrent of inward funds as the rest of the world snap up Greek property, businesses, land, wine, olives, nuts and sunshine. Greek Villa for £80,000 anyone? Prices of prime Kensington houses and apartments will fall as the recent Greek purchasers try to convert to cash to join in the rush to buy assets back home.
This inflow will create a surplus on the Greek capital account which will allow it to finance its balance of payments deficit with the rest of the world without IMF help.
The Greek Government will issue shed loads of bond to pay the wages, the Bank of Greece will Quantitatively Ease ; it will create new money to purchase them.
The drain on the Greek Exchequer will fall substantially because it will suspend all interest payments to the North.
By 2014 the Greek Economy is recovering strongly. GDP growing at 5% in real terms.
When the Greeks make their announcement, over the weekend the Germans give the ECB permission to purchase unlimited Sovereign debt (not Greek) . Northern Europe writes off €400Bn of Greek Debt. On the Monday it is announced that Spain, Portugal and Italy will stay in the Euro, and be supported by Germany. Then there will be two years of wrangling, during which time Merkel and her party lose power. The new leader is more disposed to a federal Europe, and the French as ever see some benefits for themselves and support it.
However Clubmed remains in recession, and by the end of 2014, local politics demands that either there is a Clubmed Euro or (and this is a growing probability) a departure, a default and the return of the Peseta etc.
All the above is a best guess but based on history. The chart shows that the real growth rate more than doubles post default. Grenada is the only defaulter who was worse off.
A Greek default will not be a catastrophe. It will not cause the collapse of the second largest economic zone in the world. But it will be the biggest challenge to Europe since the last war.
What will be the impact on the UK?
Europe is our biggest market. It will be in recession for the next two years. The flight to safety will push sterling towards €1.30. In combination this will make exports less profitable, but imports cheaper. Companies selling to Greece will book losses on unpaid invoices. On it’s own not a huge negative for the system. There are bigger things to be concerned about.
The double dip was expected. On limited data it appears shallow. Later revisions will show it to be deeper. All data revisions in the past 14 years show the peaks and troughs to be larger than at first thought.
The economy will barely grow this year, around 0.4%. This is because banks continue to shrink their net lending, the YoY rate of decline is 4%. It is this which is causing the lack of growth.