European leaders’ agreement to expand a bailout fund to stem the region’s debt crisis only buys time as Greece will likely still leave the euro in the next decade, Harvard University economist Kenneth Rogoff said.
“It feels at its root to me like more of the same, where they’ve figured how to buy a couple of months,” Rogoff said as a compensated speaker at the Bloomberg FX11 Summit in New York yesterday. “It’s pretty darn clear the euro does not work, that it’s not a stable equilibrium.”
European leaders bolstered their crisis-fighting toolbox by boosting the heft of their rescue fund to 1 trillion euros ($1.4 trillion) and persuading bondholders to take 50 percent losses on Greek debt. Measures also included a recapitalization of European banks and a potentially bigger role for the International Monetary Fund in strengthening the bailout fund.
Stocks surged after the agreement, extending the biggest monthly rally for the Standard & Poor’s 500 Index since 1974. Treasuries sank, while the euro strengthened and metals and oil led a rally in commodities.
The euro appreciated as much as 2.5 percent, more than 3 cents, to $1.4247, the highest since Sept. 6, before closing at $1.4189 yesterday in New York. It was the biggest rally on an intraday basis since July 2010.
“My read of this is that the markets are cheered that they’re still alive,” said Rogoff, 58, a former International Monetary Fund chief economist. “Even in a fairly short period, doubts will start to grow again.”
Debt to GDP
Still to be worked out in negotiations, which may fall prey to fresh bouts of political infighting and investor revolt, is just how the firepower of the 440 billion-euro rescue facility will be leveraged and what banks will get in return for accepting the Greek haircut. As next week’s Group of 20 summit looms, nations from Greece to Italy remain under pressure to restore fiscal order and the onus is on a Mario Draghi-run European Central Bank to keep buying bonds.
One goal of the agreement is to lower Greece’s debt as a percentage of gross domestic product to 120 percent. Nations historically have run into trouble when public debt exceeds about 90 percent of GDP, according to Rogoff.
“I don’t think there’s any doubt that we’ll see more defaults beyond Greece,” Rogoff said. “The interesting question is will all the countries in the euro still be in the euro? My answer to that is no.”
There’s at least as much as an 80 percent chance that Greece will leave the 17-nation common currency in the next 10 years, he said.
Even after yesterday’s gains, the bonds of some of Europe’s most-indebted countries are still trading near their historical lows. Greece’s two-year yield slid 285 basis points to 76.9 percent yesterday, compared with an average of 27 percent in the past year. Italy’s 10-year yield, which averaged 4.93 percent in the past 12 months, fell five basis points to 5.87 percent yesterday.
“There’s just too many inconsistencies,” Rogoff said. That multiple independent countries are using a common currency “is missing some big things and it’s just not in equilibrium.”
“This Time Is Different,” a book he co-wrote with Carmen Reinhart, a senior fellow at the Peterson Institute for International Economics in Washington, said that a recovery after a financial crisis is especially protracted and that higher levels of debt tend accompany slower growth.
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