Berlin accepts possibility of Greek default

Germany’s economy minister Philipp Roesler has written in a German newspaper this morning that Berlin is effectively prepared for any orderly default by Greece, saying there could “no longer be any taboos” in discussing stabilising the shared currency.

Writing in German newspaper Die Welt, the head of Angela Merkel’s junior coalition partners, the Free Democrats Union party, said the options “include, if necessary, an orderly bankruptcy of Greece.

“If there are breaches of the rules, there must be tough requirements…and if there are continued breaches, a withdrawal of voting rights for a time in the EU Council of Ministers should not be a taboo,” Roesler wrote.

It is an embarrassing volte face for the German chancellor’s government, as Merkel has long been a strong opponent of letting a eurozone member default on its public debts.

The euro sank below 1.36 to the US dollar this morning as news of Roesler’s comments spread, and despite Greece’s prime minister George Papandreou  imposing an emergency property tax on households, to raise €2bn.

Greece’s beleaguered leader was forced to reject calls for a snap election yesterday, as it seems increasingly likely his country will become insolvent.

Late last week the country’s official statistics office announced the economy contracted by 7.3% in the second quarter. The statisticians expected 6.9%. The office also restated first quarter economic numbers lower, to 8.1% contraction.

Greece’s central creditors – the European Union, International Monetary Fund and European Central Bank – will visit Athens this week to assess whether progress to tackle public debt is enough for Greece to receive its next aid instalment.

The bad news is not confined, however, to just sovereigns.

IMF managing director Christine Lagarde was forced on the weekend to play down stories an IMF draft document outlined a €200bn gap in capital at European banks. She emphasised the document and its calculations were “tentative”.

Axa Investment Managers’ chief strategist Eric Chaney said prompt action was necessary to “guarantee the stability of the eurozone” because of the size of Italy’s €1.6bn public debt, and “spreading crisis of trust” in the markets for Italy’s paper, and for the banking sector generally.

“Two possibilities offer themselves. First, a large scale purchase of public debt through the ECB. Because Germany has agreed to interventions by the European Financial Stabilisation Facility, the ECB could act within this new framework.

“Or maturing sovereign liabilities could be transformed into newly issued eurobonds. This would alter the market outlook dramatically and lead to an immediate price adjustment of euro-denominated sovereign paper.

“Only a limited portion of debts could be transformed and eurobonds would take precedent over sovereigns’ debt. Participation in a eurobond program would only be possible if one conducted one’s domestic affairs properly.”

Liad Meidar, co-founder of investment consultants Gatemore said problems in Europe were “overblown, with politics rather than economic fundamentals standing in the way of viable solutions.

“Yes, European banks need to continue to be recapitalised. To state the obvious, however, neither Germany nor France wants a banking crisis and ultimately will do whatever is needed to shore up their financial sectors.”

Meidar said the whole issue of European sovereign debt would “disappear from headlines when Germany makes it clear to the world that one way or another it will stand behind all debt issued by nations in the EMU. After all, if you combined the debt and deficits of European countries, the picture is not so ugly. In fact, you have an economy with lower overall debt and primary deficit to GDP than the US or the UK.

“The issue is entirely about who will pay. Will it be the ‘spender’ nations paying for it through austerity measures, or the ‘saver’ nation – Germany – paying through bailout funds and/or increased borrowing costs for itself over the long term?

“The solution will likely involve both elements, but this issue will continue to agitate markets until Germany concedes the inevitable – that it will largely foot the bill itself. Germany undoubtedly would have the most to lose if the EMU were to collapse – it would suffer a massive banking crisis followed by a currency that would choke off its exports – yet it may not have the political will to provide unfettered support to European debt until after the elections in 2013. Until then, we can expect a series of partial measures, and a continued bumpy ride.”

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