INSIGHT: It’s when not if for Greek default, new global recession

15 September 2011 16:17  [Source: ICIS news]

By Joe Kamalick

WASHINGTON (ICIS)--It is not so much a question of whether Greece will default on its sovereign debt – just when, according to top economists.

A Greek default, perhaps within weeks, would trigger a new contagion of contraction in Europe that would likely spread worldwide, perhaps precipitating a global recession.

“Let us take as a given that Greece will default on its bonds,” said Carl Weinberg, chief economist at High Frequency Economics (HFE).

When that happens, Weinberg said in a note to clients this week, the result will be a shutdown of commercial credit throughout Europe and the onset of a years-long depression in the region that will infect the US, Asian and Latin American economies as well.

Given European and some US banks’ exposure in Greek bonds, the dominoes will fall quickly, Weinberg said.

“Repricing bonds with nominal face values of €3,000bn [$4,110bn] to 50 cents on the euro will impair the balance sheets of the banking system so much that banks will be forced to stop lending,” he said.

“Without credit, economies will atrophy. Without credit – and with government spending impaired in major EU economies – euroland will fall into an economic depression from which it will not escape for years,” Weinberg said, adding: “That is our forecast.”

That dire outlook is not an extreme view.

Kris Bledowski, counsel director and economist at the Manufacturers Alliance, and a eurozone specialist, shares much of Weinberg’s dour forecast for the European debt crisis.

“Greece’s default is highly probable,” he said. “The timeframe could be late this month or early October when the IMF [International Monetary Fund] and ECB [European Central Bank] are due to release another tranche of €8bn to Greece.”

“But Athens is supposed to meet three conditions to qualify for the tranche: structural reforms; a bundle of steps that Greece has to take on a schedule; and, third, numerical targets on revenue from privatisation,” Bledowski noted.

“But come this month or October, Greece will fail on all three counts, which means the IMF will refuse to disperse the tranche,” he said. “Greece at that point will be unable to refinance its debt and it will stop paying its creditors.” In a word, default.

Bledowski suggested that the IMF and ECB could go forward with the €8bn tranche to Greece, even if Athens does fail to meet the three bail-out conditions, but in that scenario the Greek default is not avoided, merely postponed until the next scheduled tranche in early 2012.

In either timing scenario, Bledowski agrees with Weinberg that the Greek default would first hit Europe’s banking sector because it is so heavily exposed to Greece’s bonds.

“They would have to write down those losses, and banks will go into an extremely conservative, defensive position,” he said. “Europe is more monetised on the banking side than the private sector, and a lot of businesses in Europe rely on short-term bank loans, so the contraction in banking would make it difficult to get financing for operating capital, inventories – it would be very troubling for smaller companies.”

“Then at that point a new European recession is very likely,” Bledowski said. “Europe today is much closer to the floor, so to speak, than the US. Their growth rate has been much lower than in the US, so it will be easier for them to fall.”

“If Greece defaults, a European recession is very, very likely,” he added. However, Bledowski parts company with Weinberg on depression.

But even if Europe slips into a recession rather than a depression, “there would be [a] substantial effect on the US”, Bledowski said. As in Europe, the first impact in the US from a Greek default would be in banking, with banks hunkering down into a defensive mode, and much less likely to issue loans.

Bledowski does not think a Greek default on its own would necessarily tip the already-wobbly US economy into a new recession. He puts the odds of a new US recession at no more than 60% if it is only Greece that goes under.

“But should there be a dramatic additional crisis in Europe, a panic, a dramatic collapse of confidence, Greece leaving the eurozone, then sentiment would be hugely impacted and a recession in the US would only be a matter of time,” he said.

Kevin Swift, chief economist at the American Chemistry Council (ACC), also agreed that the dark HFE forecast “is a very plausible, believable scenario”.

“Greece is in a very bad situation. The Athens government is getting a lot of pushback by the population on the austerity measures, and their default looks like a very likely option, highly probable.”

If Greece defaults, Swift agreed that the resulting evaporation of bank credit would tip the EU into recession. And it was likely it would not be confined to Europe.

“The EU sovereign debt situation is the biggest risk to the world economy, and by extension the US economy as well,” he said.

“The EU represents about 25% of global GDP,” he noted. “If Europe slips into recession, it will have [an] effect on headline global growth, it will reverberate around the world.”

He said that US chemical industry exports to Europe would of course be affected, and that trade volume is already slowing, with current chemical exports to the EU running flat with last year.

Larry Sloan, president of the Society of Chemical Manufacturers and Affiliates (SOCMA), sees a Greek default and a likely EU recession as having a double impact on US chemicals.

He said that weakened consumer demand in Europe will trickle up through the manufacturing supply chain, and first adversely affect direct US export chemical sales.

But it would eventually also impact domestic US chemicals demand as manufacturers of products that rely on chemicals as components or in processing see their European sales decline.

“This is not good news for the overall US economy,” he said.

In the middle of the week, Germany and France were huddled in an effort to stave off a Greek default.

Germany's Chancellor Angela Merkel on Wednesday strongly rejected suggestions that Greece would be forced into default.  But there is considerable opposition within her own ruling party and among the broader German populace to pouring still more cash into the sick man of Europe.

There is also opposition to more IMF and ECB blank cheques for Athens among the Dutch, Finns and Austrians.

So if Merkel cannot round up a solid EU front to fund ongoing monetary transfusions to Greece, Germany is not likely to go it alone.

What happens next is anyone’s guess.

“We can only speculate, because we have never seen anything like this before,” said HFE’s Weinberg.

European Commission president Jose Manuel Barroso told the European Parliament this week that the eurozone debt crisis “is the most serious challenge of a generation”.

 ($1 = €0.73)

Paul Hodges studies key influencers shaping the chemical industry in Chemicals and the Economy

By: Joe Kamalick
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