Monday, June 29, 2015

Looking for Signs in Currency Turmoil

It was a shocking series of events that brought Greece to where it is today. It was literally the last chance for the EU and IMF to mess up the Greek economy, and they seized the moment. They withdrew the agreement in principle that seemed to have been reached on Tuesday and threw a grenade into negotiations on Thursday in the form of a new demand for economic restructuring that would have cost an already depressed Greece two or three million more jobs. Thursday, of course, was too late to allow any chance for Greece to make a meaningful response to a negotiation reset.

Why did they do it? It is pretty clear that European negotiators were playing for a respectable profit on their dealings with Greece in a situation that called for them to minimize their losses instead. When investors press for gains that aren’t there, they take risks that a sensible person would never consider. They take these risks because they can’t believe how much the investment climate has declined. It is easy to see how large the risks are on Monday morning with the euro down 0.5 percent and the largest European bank stocks down 4 percent, losses in either case many times the total amount directly at stake in the Greece talks. So is this irrational risk-taking at the highest levels a sign that the recent boom times in Europe are over?

It is easy to be pessimistic with a run on the banks, a stock market rout (especially in China, down 20 percent in three weeks), and the endless speculation about the euro falling apart. I worry somewhat about the paucity of news coverage for what could easily turn into the biggest currency crisis ever. Much of the commentary seems to be pointed toward getting the parties involved to return to the negotiating table, and that is a mistake at this point with the effective deadlines having already gone by. The next talks may involve different parties and will have to address a very different situation.

In retrospect, the last two months of European talks were a costly distraction for top officials in Greece. This week Greece has to proceed as well as it can with the reforms it has been talking about in May and June. It must also prepare to issue some form of quasi-currency so that the Greek economy can continue to function with so little real money inside the country. The EU will be preparing to prop up major banks in Germany, Italy, and Spain with the quarter trillion euros in emergency liquidity it is said to have at the ready, but it must also look for new approaches to solve problems in what is now shown to be an exceedingly fragile currency union. Halfway around the world, there is a crisis of sorts in export-dependent China, which may face some adjustments of its own if its customers across Europe are forced into new spending cuts. It is uncharted territory and there is a lot to watch out for, so it won’t be a surprise if the news media struggles to keep up with the story.