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Too small is ‘too big' to fail

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S. Gurumurthy

“PIGS in Muck” — this was how, using the acronym ‘PIGS' for Portugal, Italy, Greece and Spain, the Financial Times London had titled an edit on August 31, 2008. Contrasting the decline of the ‘PIGS' with the rise of the ‘BRICs' (Brazil, Russia, India, China) the Financial Times, London, wrote that the acronym PIGS was pejorative, meaning negative, ‘but one with much truth'. The Portuguese Finance Minister angrily denounced this comment as ‘racist'. Yet this acronym that originated in 1997 as a collective reference to the four Southern European states is now part of the global financial literature.

The PIGS have many things in common. Like Greece, the others too have high, unsustainable, levels of public debts and foreign loans.

NOT JUST GREECE

If Greece looks like Lehman Brothers, the other PIGS constituents look no different. If Greece's public debt rated to GDP is risky at over 125 per cent, Italy (over 115) is as bad. If Greek's external debt to GDP is bad at 187 per cent, Portugal (218) and Spain (229) are far worse. If the unemployment in Greece (9.8 per cent) is dangerous, it is worse in Spain (20.5) Portugal (10.5), and nearly as bad in Italy [8.6). If the fiscal deficit of Greece (12.7 per cent) is high, it is no different in Spain (11.4) with Portugal (9.3) not far behind. In per capita income, Greece ($32,100) scores over Portugal ($21,700) and Spain ($22,486) by a wide margin.

In inflation, all in the PIGS except Spain are in the band of 0.5-1.0 per cent. And if just one in 50 Greeks is poor, every fifth Portuguese – and Spanish – is poor. In external deficit as a proportion of GDP, Greece (13 per cent) does fare badly; but Spain (11) is no better; Portugal (7.6) is better but still bad. Yet Greek's overall external debt rated to GDP is better than that of both Spain and Portugal.

Why then did Greece faint, and first? Because it did what others did not. By a process of elimination, it is the guilt of fudging of its national books that singled out Greece as a sinner. This sin, a decade old, was first committed by Greece on the advice of Goldman Sachs, to gain entry into EU. The infamous banker taught the ancient country how to use modern derivatives to understate its deficits and debts.

What Greece did there was almost similar to what Ramalinga Raju did here to cook Satyam's books. And again Greece, like Raju, confessed to its guilt in 2994. But, unlike Raju, Greece continued to fudge its books. It confessed, for a second time in 2009, that its true fiscal deficit is four times the normative 3 per cent! It is this total loss of credibility that did Greece in, not just bad numbers.

Unlike in 2008, now it is no more just PIGS that drag the EU down. The PIGS club has now expanded, with Ireland first, and ironically, Great Britain next, as the newly qualified members of the PIGS, making it PIIGGS (adding another ‘I', for Ireland and another ‘G', for Great Britain).

See how the new entrants qualify. Ireland's external debt is $1.841 trillion – some 960 per cent of its GDP; its public debt is above 62 per cent; its current fiscal deficit is almost 15 per cent. Great Britain's public debt is almost 70 per cent of the GDP; its fiscal deficit is over 11 per cent; its gross external debt is $9.191 trillion (365 per cent of GDP). The two new entrants eminently qualify to rank as part of the “PIIGGS in Muck”.

EURO IN DANGER

The financial packages in 2008 were devised to protect the economic actors who were ‘too big to fail', to save the system. But Greece is too small an actor in comparison, specifically as compared to the size of the EU economy. Its GDP is just 2 per cent of EU's; its stock market-cap, just 1.25 per cent; its public debt only 3.95 per cent; its private debt, a measly 0.81 per cent; its total debt, just 1.76 per cent; its bank assets, a mere 1.11 per cent!

Greece, a spot in the EU, is a dot in the world. Yet, this tiny dot is threatening to cause a global crisis. How? The tiny Greece is a symbol of the larger PIIGGS. The share of PIIGGS in the GDP of EU is large, about 40 per cent; its share in the total EU debts is over 50 per cent! Its debt to GDP ratio is 62.4 per cent.

So Greece is just the starter, as what happens to Greece today would envelop PIIGGS tomorrow. That will devour the EU and Euro Area the day after. That may well be the end of the euro. Look at just two numbers. One, according to the IMF report on Global Financial Stability (April 2010) out of the total capital flows of $24.8 trillion up to 2009, contracts for $12.4 trillion — over 50 per cent — have been inked in the euro.

Two, the Bank of International Settlement says that the outstanding derivative contracts valued at over $180 trillion stand transacted in the euro. Does it need a seer to say that the end of the euro could well be the end of the global financial system? The euro is suspect because it has no Godfather to defend it. The US Fed will defend the dollar to its last drop of blood. Who will die defend the euro like that? Angela Merkel seems to have already written the last cheque in Euro's defence.

That such a thing — so anything — can happen is what the Modern Greece's Tragedy 2010 reveals. That the too-small Greece has now become ‘too big to fail' testifies to how the global financial system is on the edge.

That the West now perceives such a marginal actor as such a fatal threat when the West just laughed off the collapse of much larger Asian economies in 1997 as just crony capitalism meeting its fate, speaks volumes. The reason for its fears today is self-evident.

FRAGILE FINANCIAL SYSTEM

The world financial system, say insiders, is now heavily leveraged — estimated at $17 trillion. Leverage, in simple words, means controlling a large asset or handling a big debt by risking small real money, like buying an option to acquire shares of Rs 100 lakh in value by risking just Rs 5 lakh as premium. Or the world's outstanding derivatives of over $600 trillion is backed by just some $ 25 trillion (4.2 per cent) of real money. The heavily leveraged world of modern finance is like a pyramid of cards, which the fall of a tiny Greece can blow to smithereens.

As an expert put it, ‘the last thing the drunk should be given is another drink'. Yet that is precisely what the West does now by issuing more paper monies to solve the crisis created by excess paper monies that have turned toxic. Adding further toxin will only add to toxicity; it will not detoxify.

This realisation will come only when much of the financial economics taught in the last three decades is, as the Nobel Laureate Dr Paul Krugman said bluntly, trashed as “useless at best and positively harmful at best”. That is a subject by itself.

(The author is a corporate adviser.blfeedback@thehindu.co.in)

Related Stories:
Greece: Europe's ‘Trishanku'
How to douse the Greek fire

(This article was published in the Business Line print edition dated May 26, 2010)
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