Storm clouds gathering over Europe. Things are looking bleak, really bleak…

A year or so ago we told you that Greece was bankrupt, that it was facing only impalatable choices, but that the European rescue efforts bought time.

A year later things haven’t improved, quite the contrary:

• It’s clearer than ever that Greece is bankrupt, the situation is so dire that there is even talk about Greece leaving the euro
• While Germany battles with the ECB for a restructuring of Greek debt (and the ECB is not playing ball, to put it mildly), Greece seems to have little cash left
• While selling assets like public companies looks to be the last card the Greeks can play, there are some awkward questions to be asked here (see the end of the article linked directly above)
• In these crucial times, a crucial person (DSK) seems to have succumbed to an overdose of testosterone
• The rot has spread to Ireland and Portugal
• And is spreading towards Spain, Italy, Belgium
• In Spain, like everywhere on the EU periphery, the population is tired of austerity with almost 22% unemployment and 45% youth unemployment. The latter in particular 
• S&P lowers Italy’s debt outlook to negative but it’s government (the Prime Minister in particular) have ‘other’ worries and preoccupations..
• The economic divide between core and periphery in Europe is widening, with several Northern European countries posting stellar growth, prompting the ECB to rate hikes which send the euro higher (albeit recently coming of the highs near $1.5), the last thing the PIIGS need.

The truth has always been:

1. Most of the PIIGS have a spiraling debt problem, as well as a competitiveness problem
2. While some inflation would help the debt problem, it would worsen their competitiveness, a real Catch-22
3. Bound by the euro, they can’t devalue (and thereby restructure it’s debt), like Argentina did in 2002 in similar circumstances
4. Austerity was always going to make things worse in the short-run
5. There always was an upper limit to the population’s tolerance of this. Whole generations in Greece, Ireland, Portugal and Spain lay to waste
6. There always was an upper limit to the tolerance of ‘European solidarity’. For too long, the European political class has used the EU as a scapegoat for unpopular measures while taking policies were often far ahead of the public. This strategy is now risking a serious backlash.

The big question is, of course, can there be an orderly restructuring of Greek debt? The sight of the ECB kicking and screaming against any restructuring surely doesn’t inspire a whole lot of confidence. Greek banks have been gorging themselves on Greek bonds, and then disposing these to the ECB under the liquidity program, hence they’re first in the firing line

• Greek banks have been playing funny games
• The Greek banks carry trade in Greek sovereign bonds kept yields relatively low and enhanced the bank’s earnings
• But the ECB is threatening to end the game
• EU and ECB programs have acquired 190B in Greek debt, with 180B in the private sector
  

Those last figures seem to suggest that a Greek ‘haircut’ of 30-50% wouldn’t be the European bank disaster some claim it to be, unless it triggers a domino effect in other PIGGS. There are more catastrophic scenario’s though:

• What happens when Greece defaults

In any case, we now know why European banks are cleaning up their balance sheet with considerable urgency

Most likely scenario, for now, kicking the can. The Europeans will once again stall, throw some more money to Greece, urging it to make progress with asset sales and tax collection and buying time hoping growth will restore which will make the evolution of debt/GDP numbers look somewhat less dramatic.

They have the money to do that, but whether it works is another matter. In the mean time, the rumblings from the likes of Italy and Spain are getting distinctly louder..