Europe Faces a Two-headed Monster of Debt and Oil
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The Fiscal Times
January 30, 2012

It looks as though we have a deal between Greece and its private-sector creditors, and not a moment too soon. The announced agreement over the weekend ended months of handwringing and protracted talks between the government of Greek Prime Minister Lucas Papademos and Charles Dallara, head of the Institute of International Finance, which represents most foreign lenders. Final details will be presented this week, according to news reports quoting those close to the talks.

Christine Lagarde, the new managing director of the International Monetary Fund, was notably pointed last week as to the threat a possible Greek default would have not just to the eurozone, but to the global economy. In a warning shot to the European Central Bank, Lagarde stressed the ECB should be willing to share some of the suffering to make the Greek deal work. At present, the ECB, which holds about $70 billion in Greek debt, has declined to accept anything less than face value on its Greek portfolio.

You have to wonder how private creditors will react to that position since they will trade their Greek bonds for new instruments with a 50 percent discount on the face value. With a lower interest rate (between 3 percent and 4 percent, which is very cheap money for the Greeks just now) and a long-term maturity, the total hit for private creditors, who hold slightly more than $263 billion in Greeks bonds, will exceed 70 percent.

It is a “voluntary” agreement, but we cannot do without the quotation marks. Any creditor who does not participate could well find itself with worthless paper. It is also an essential agreement. Once it is sealed, the door is open for Greece to continue drawing on the $171 billion from international lenders fixed as part of a long-term rescue package last October.

This is how the European puzzle will be assembled. But the Continent is hardly out of the woods. On Friday the rating agency, Fitch downgraded five European economies, including Spain and Italy. And there are mounting concerns that Portugal may soon need a second bailout if it is to repay $12 billion in debt due next year. The IMF estimates that even a successful deal now will cut Greece’s debt-to-GDP ratio to 130 percent by 2020, still short of the targeted 120 percent.

A correspondent, editor and critic for more than 30 years, mostly for the International Herald Tribune and The New Yorker, Patrick Smith has also lectured in journalism and media studies. He is the author of five books.