A World of Problems

Guest Post by The Zman

Back when the Germans were threatening to shut down Greece and sell it off for parts, it was fairly obvious that there was no way to “fix” the Greek problem. Even it were possible to radically overhaul their public sector, the debt payments are too high to maintain the level of social services expected from a modern social democracy. Default was unthinkable because close to 80 percent of Greece’s public debt is owned by public institutions, primarily the EU governments and the ECB.

The “solution” was to kick the can down the road until a miracle happened, but now the problem is back.

ATHENS—Greece’s economic recovery is proving elusive, challenging the forecasts of the country’s government and foreign creditors still counting on growth reviving this year.

The International Monetary Fund said last week  that the economy is stagnating, in the first admission from creditors that Greece’s recovery is off track again. Growth will only restart next year, the head of the IMF’s team in Greece said on a conference call with reporters, without offering details.

Of particular concern is that exports, which are supposed to lead Greece out of trouble, are on a slow downward trajectory, hampered by capital controls, taxes and a lack of credit.

“There is no chance we will see a rebound unless we see some bold political decisions that would introduce a more stable business environment,” said Dimitris Tsakonitis, general manager at mining company Grecian Magnesite.

The bailout agreement between Greece and its German-led creditors assumes rapid growth from late 2016 onward, including an official forecast of 2.7% growth in 2017. Private-sector economists believe next year’s growth could be closer to 0.6%.

Weaker growth would undermine the budget, likely leading to fresh arguments with lenders about extra austerity measures.

Greece is still grappling with the measures it has already agreed to. Late on Tuesday the country’s parliament approved pension overhauls and other policy changes that have been delayed for months, holding up bailout funding.

Greek government officials are sticking to their view that the economy is on the cusp of growth. “We are at the turning point at which we can we say with certainty that we are leaving the recession behind us,” Economy Minister George Stathakis told supporters of the ruling left-wing Syriza party Sunday.

The economy will get a push from investors as of the end of the year, when lenders are expected to provide some debt relief and the country qualifies for a European Central Bank bond buyback program, Prime Minister Alexis Tsipras said in an interview with The Wall Street Journal last week.

In other words, the miracle did not happen and the problem is now worse. This comes at a time when Europe’s biggest bank is in very serious trouble.

Hedge funds have started to pull some of their business from Deutsche Bank, setting up a potential showdown with German authorities over the future of the country’s largest lender.

As its shares fell sharply in New York trading, Deutsche recirculated a statement emphasising its strong financial position.

European regulators and government officials have kept a low profile in public over Deutsche’s deepening woes. However, in private they have struck a sanguine tone, stressing that in extremis there is scope under European regulation to inject state funds to support the bank, provided it is done in line with market conditions.

Marcel Fratzscher, head of DIW Berlin, a think-tank, said: “If push comes to shove, the German government would contribute because Deutsche Bank is the only global bank that Germany has.”

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There is one solid rule with banking and that is when the biggest bank is in trouble, all the banks are in trouble. The reason is a bank in trouble seeks to increase its cash by unwinding its holdings. This puts downward pressure on the price of those assets, which forces all banks holding similar assets to revalue and perhaps raise their cash holdings, by selling assets. This can easily set off a cascading effect, which is popularly referred to as contagion. The ghost of Lehman now haunts Deutsche Bank.

Deutsche Bank has something north of €42 Trillion in derivative exposure. To put that into perspective, the GDP of Europe is €14 Trillion. The phrase “systemic risk” is starting to pop up in news stories for obvious reasons. Presumably the German government would step in and bail out the bank, but this is the same German government that invited millions of Muslims into the country. That and no one really knows how big the problem is at Deutsche Bank. There’s nothing more dangerous in the financial world than uncertainty.

If that’s not enough to have you stocking up on potable water and MRE’s, the news brings word that the Obama Administration is trying its best to start a war with Russia over Syria. They are ending talks with the Russians over the bombing of Aleppo. The Russians are threatening to impose a no-fly zone, while John Kerry is making noises about sending troops to Syria. The US position is completely nuts, which is what makes it so dangerous. The same people who screwed this up are now tasked with avoiding a mistake that will lead to a shooting war with the Russians.

The world always has some problem that could get out of control and bring the whole thing crashing down, but the odds are usually long enough to not worry too much. Pakistan is now threatening to nuke India, but that happens often enough to not take too seriously. Pakistan’s military understands that they will lose a real war with India. India understands that they will gain nothing by winning a war against Pakistan. This is one of those problems that can be managed by the permanent diplomatic service, with little help from the political class.

The three crisis I’m following all have some things in common. One is they will require hard choices from the political class to contain. In politics, a hard choice is one that causes a politician to lose support. Merkel’s government is already teetering so how willing is she going to be to make a bold move to rescue Deutsche Bank? The ECB proved unable to deal with the Greeks the last time. If Merkel is facing a financial crisis, who will she play bad cop with the Greeks when Tsipris inevitably comes calling, demanding a break on Greek debt?

The Syria debacle is the most concerning because it resembles so many European problems of the past. There’s a Seven Year’s War quality to it where you have two main players with the rest changing teams after every stage. With the US now increasing the troop levels in nearby Iraq, presumably to fight in one theater of this conflict, the chances of a mistake increase. In these situations, mistakes are often not mistakes, but even when they are, they become reasons to abandon dialogue in favor of military options.

We live in a world of trouble. One can be forgiven for having a sense of foreboding.