Greek referendum - necessary but risky

Greece announced yesterday that it will hold a referendum regarding the latest bail-out package among its citizens together with a vote of confidence in the parliament. The question asked from the Greeks is whether they want to adopt the latest aid package or not. It is a "yes" or "no" question which makes it a dangerous one. But first I will outline the core of latest bail-out package to Greece:

• 50% write-down of Greek bonds (meaning that current holders of Greek debt will suffer a 50% loss)
• 130 billion euros 
• further austerity measures and reforms including selling of Greek assets, sacking of numerous public workers, raising taxes etc

All this should reduce Greece's debt burden to 120% by 2015. Greece should return to growth from 2013 (its economy will contract about 5,5% this year). 

The announcement was shocking because reforms carried out in Greece are not popular, yet they are important in order to get support from IMF and EU. The reasoning here is that solvent EU members want Greece and other historical big spenders to behave according to rules and promote economic growth. By supporting Greece and other PIIGS (Portugal, Ireland, Italy, Greece, Spain) the EU can push these countries to carry out painful reforms. 

Now Greece has put the latest package to referendum. While it is good for democracy it may not be good for Europe. Recent polls show that majority of Greeks think that bail-outs are bad or probably bad to Greece. This is because there are no people in Greece that aren't in some way affected by reforms and austerity measures. 

"No" in the referendum held would mean that the government would step down and new elections would be held. This would theoretically cause the IMF and EU withhold their support money causing Greece to be unable to pay out salaries for months possibly. Even though I am fairly positive that even then some agreement with EU and IMF would be reached, it will cause panic and market tumble wiping trillions off bank accounts. Would Greece leave the euro then? How would Greece deal with all this euro-nominated debt if their currency would depreciate 50% for example? What would be the effect on Greek economy? Just look at Icelandic example for that matter!

"Yes" in a referendum would be the best outcome of all since the people of Greece would show their support to change what current Greek austerity measures are all about. This would make it easier for the government to carry out reforms and would win the total support of the parliament as well. Let's hope that Greek prime minister Papandreou knows what he is doing. 

Against EFSF? Really?

Estonia's parliament will vote on expanding the powers of EFSF tomorrow together with Germany. As always media and politics have managed to develop a circus out of the discussion preceeding the vote. Polls show that Estonian people are mostly against expanding EFSF (also those supporting our current right-liberal government). Some of the people shout out arguments like "Greece should go bankrupt" or "Why do we have to feed banks". This was followed by a statement from our centre (populist) opposition party that they also don't support joining the EFSF probably hoping to get some votes. Since people are getting very emotional on this subject I will lay out some most important facts about EFSF. (Check these out yourself HERE)

1) First and foremost - EFSF was created with an intention to preserve financial stability in the eurozone by providing temporary financial assistance to governments or banks in difficulty. In other words it is supposed to AVOID crises like we are in now.
2) EFSF finances itself by issuing bonds that are guaranteed by all 17 eurozone countries up to 440 billion euros. Countries participating in EFSF do not pay any additional funds to EFSF, it is backed by guarantees.
3) EFSF is only a temporary measure to handle the current crisis and its permanent follower will be ESM or European Stabilisation Mechanism.

Q: What happens if a country doesn't participate in the EFSF?
A: There's a risk that other countries don't want to particpate as well, who will finance the EFSF then?

Q: Why do we need EFSF at all?
A: To avoid uncontrolled bankruptcies of banks and countries

Q: Why do we need to avoid their bankruptcies if they have overspent?
A: Since if we don't borrowing costs for countries like Italy, Spain, France, Belgium etc will rise significantly leading to other bankruptcies. Banking system as we know it might fall because of the losses that these banks will have (the banks are holding the bonds that are worthless after a bankruptcy of a country). There will be no more euro.

Q: What happens if euro goes?
A: Countries like Germany, Estonia, Finland, Netherlands etc that are financially sound will get currencies that will rise significantly in value causing our exports to fall greatly (it is then more expensive for other countries to buy our products). This will bring massive unemployment and loss in economic welfare. It has been estimated that the effects of such an event would lead to 20-40% fall in GDP in first year. For countries like Spain, Italy and Greece this might even leed to civil war since their currency would devalue so greatly that the people of these countries are unable to pay off their loans. There would be massive unemployment since there is no funding for investments (who would borrow to a bankrupt country in civil war?). GDP of these countries could even fall 50% or more. (Analysis is done by UBS).

The total loss of these events will surpass trillions of euros (if you look at European GDP of about 12 trillion EUR). The countries going through tough austerity measures including budget cuts and reforms will hopefully turn to growth in a couple of years. It is not like regular people of these countries aren't suffering enough already. Hasn't Europe learned anything from its history just 70 years ago? It's not like we are not on the edge of a cliff..

What happens to a country after leaving the euro?

Who hasn't heard of a populist politician arguing that a country should leave the eurozone and be better off? I've had many discussions on this subject but as long as we don't have a precedent we really don't know what will happen. Anyway we have some calculations by UBS Securities (LINK) and I quote:

Ahead of the German constitutional court ruling on bail outs, we have assessed the cost of countries leaving the Euro. For a weak country the cost is 40%-50% of GDP in the first year. For a strong country like Germany the cost is around 20-25% of GDP.

Economic costs of break-up dramatically exceed the costs of bailing out weaker states. Political costs also need to be considered. Virtually no monetary union has broken up in modern times without some trend to authoritarian or military government, or civil war.

The cause for such a major crash is loss of credibility, default, collapse of banking system etc. I wonder whether the same people arguing against war in Iraq for example are arguing against bailing out countries like Greece which could turn into civil war? I wonder how the protesters below expect governments to fund basic needs of people with a scenario described above?

It is easy to be populist because it is good to be popular. Next time you hear somebody arguing their case about Greece, Italy or Iraq ask them about alternative theories - what should we do then (and don't settle with an answer "don't bail-out a country") - because that's what we usually see and hear - populist thoughts without a credible alternative.

Finland vs Greece vs Europe

No, it's not a football match I'm going to write about, even though Greece would have a much bigger chance succeeding there. Finland has gained much attention recently since their prime minister announced that Finland has gotten monetary collateral for supporting Greece. This means that Finland agreed to support the second bail-out package to Greece only if Greece would deposit equal amount of money as a collateral for Finland. If Greece would go bankrupt, Finland would keep the money.

For Finland this is mainly a domestic political campaign. Finnish voters are turning anti-euro and the government had to do something in order to win some votes back. For Greece, guaranteeing collateral was one way of securing the votes of all countries, including Finland.
Other countries in the eurozone though are (rightfully so) upset because if one country gets collateral, why shouldn't others? This would eventually lead to a situation where all the money borrowed to Greece would be deposited somewhere as collateral and there would be no money left for Greece to cover its costs. Is there any solution for this?

Seeking collateral for the money borrowed to Greece would be a good idea since this would discipline Greece as well. What could be used as a collateral though? One possibility could be natural resources. In 1992 my home country Estonia successfully carried out a monetary reform which substituted Russian ruble with Estonian krona. Estonia initially used our national forest and gold reserves as collateral for the krona. So let's look at Greece's natural resources and other reserves (from CIA World Fact Book):

• 991 million cubic meters of natural gas with a market value of around 138 billion USD (Bloomberg)
• 6,37 billion USD in gold reserves
• 10  million barrels of oil with a market value of around with a market value of around 1,1 billion USD (Bloomberg)

In addition to that Greece has deposits of bauxite, asbestos, nickel, magnesite and marble. So Greece just might have enough natural resources to at least partially put out a collateral for money received from other eurozone countries and the IMF. As a matter of fact natural gas, gold and oil reserves add about up to the total amount of the most recent bail-out package of 110 billion euros.