Position...

I agree with most of this, and would only add there will be a large security premium attached to sovereign debt issuers who can provide it. This of course leaves the U.S. in the pole position.

By Mohamed El-Erian

Published: April 7 2010 15:53

It should be apparent to all by now: despite the rhetoric out of some
European capitals, the Greek rescue package is not going according to
plan.

The triumphant Greece/European Union/International Monetary Fund
announcement of a couple of weeks ago has not calmed markets, nor has
it lowered Greek borrowing costs. In fact, market measures of risk
signal more concern today than before the announcement.


Meanwhile, worries are mounting about the health of the Greek banking
system, raising the spectre of disorderly outflows of deposits.
Society is not buying into the government’s adjustment plan. And the
EU/IMF external financing package lacks the operational clarity that
is required in these circumstances.

Veterans of past sovereign debt crises will not be particularly
surprised by this turn of events. As illustrated by Mexico in 1995 and
Korea in 1997, among many others, complicated sovereign rescue
packages often have to be re-opened. In some cases, such as Russia in
1998 and Argentina in 2001, the packages never succeed in getting
ahead of deteriorating debt dynamics.

Unfortunately, it is likely that things will get worse for Greece
before they get better. In the short run, the persistence of alarming
risk spreads will lead to even more cautious behaviour among
depositors and investors. Late movers will sell Greek assets rather
than buy, putting even greater pressure on the government’s ability to
raise sustainable funding for its forthcoming debt maturities in May.

Against this background, we should expect an intensification of the
European blame game in the weeks ahead. Greece will complain about the
lack of meaningful support from its European neighbours. They, in
turn, will point the finger right back, noting the urgent need for
Greek austerity. And the IMF will be pulled in all directions,
including by those hoping that the institution can engineer an
immaculate recovery for Greece.

Ironically, the major issues in this complex case can be summarised by
a relatively simple observation: that the solution to Greece’s
problems is undermined by the inability of the major players credibly
to commit to the required high level of co-ordination and trust.

The Greek government is having difficulty convincing its people of the
magnitude of the country’s problems and the required internal
adjustments. As a result, Greece is unable to provide sufficient
assurances to its creditors, thereby further complicating an already
tough situation. This accentuates the hesitancy of exceptional
financiers, such as Germany, who resist having to again pay the bill
after others have partied. And without exceptional financing, the
Greek government finds it even more difficult to embark on an
adjustment program that relies on only one instrument – that of fiscal
austerity.

It is a classic co-ordination failure in game theory. Any first mover
will become worse off. Indeed, it is in the interest of any single
party to wait for others to move first. As a result, no meaningful
progress is made, the problems fester, and the risks of a disorderly
outcome increase.

Buoyed by a cyclical recovery, markets around the world have yet to
recognise the complexity of this situation. When they do, it will also
become apparent that Greece is part of a wider, and historically
unfamiliar phenomenon – that of a simultaneous and large disruption to
the balance sheet of many industrial countries. Tighten your seat
belts.