While news of the Eurozone deal to solve the Continent’s debt crisis has buoyed markets across the globe, the pathos playing on investors’ emotions is likely to be sustained over a few more acts of the doleful Greek tragedy that has gripped the economic stage the past two years.
The outlines of the deal reached in the wee hours of Thursday morning seem clear enough, though like many a Greek tragedy the gap between appearance and reality may greatly diverge. Under terms of the agreement, private investors are to take a “voluntary” 50% haircut on Greek debt–to avoid a technical default (this is intended to avoid a credit event that would raise borrowing costs); the banks taking the haircuts get 21 billion euros in aid to sweeten the deal; the European stabilization (i.e., bailout) fund gets quadrupled to somewhere over $1 trillion euros with some private investor participation; and Europe’s shakiest banks get recapitalized to the tune of 106 billion euros.
But the straightforward-seeming details raise many questions: Will the avoidance of a technical default really stave off higher borrowing costs? Will private investors really want to own the new Greek bonds, or those of other PIIGS countries without rates rising to unsustainable levels again? Does the recapitalization of the banks come anywhere near the amount needed to assure their financial soundness?
The news that seemed most reassuring to investors–the raising of the European stabilization fund to north of $1 trillion euros begs some questions too. Where will all that money come from? What will induce private investors to participate? Is it enough to cope with the continued economic weakness of Greece and the other PIIGS countries whose potential bailout requirements may be quite high?
Indeed, the biggest reason to not uncork the champagne just yet is the unsatisfactory new status quo Greece will now be in; the 50% private investor haircut serves only to bring Greece’s debt-to-GDP ratio down to 120% (hopefully) from above 160% currently. But that is a level of debt which economic research suggests is beyond sustainability.
A comprehensive study published last month by the Bank for International Settlements suggests that debt in excess of 85% of GDP acts as a strong drag on growth. Greek austerity measures, strikes and national psychological and economic depression have been shrinking the Greek economy in the past years and the high value of the euro continues to make Greek tourism uncompetitive internationally.
These same issues also affect Spain, Portugal and Italy. It is therefore hard to imagine we won’t be seeing the anguished faces of French President Nicolas Sarkozy and German Chancellor Angela Merkel–or their successors–struggling to work out the next big rescue deal sometime soon.
In the meantime, traders had a good day Thursday, with the S&P 500’s 3.35% rise (as of midday) boosting October’s stock market performance to the biggest monthly gain since 1987.
It is impossible to account with certainty for the movement of stock prices. Indeed, stocks have delivered impressive returns during the past two years this Greek crisis has played out. But there have been deep swoons in between the giddy upward movements that we are likely to again in subsequent acts of Europe’s Greek tragedy. And the persistent economic problems the U.S. continues to face will likely further ensure the continuation of heightened volatility.
But through it all, stock investors may be on to something. Crises on both sides of the Atlantic point to the failure of governments–while the ability of businesses to deliver goods and services people are willing to pay for has ensured companies’ ability to deliver profits to shareholders through even dismal economic conditions.