A potential solution for Greece, Argentina and other countries with large debt loads – and a new world order

Date: 20 Apr 2015 Comments: 0

Eurozone - Plan BHeavily indebted countries around the world have had to face a number of different problems; in Europe, the Euro-based member states struggle with a currency that is over-valued for the weaker economies, while elsewhere Argentina in particular is having to deal with a local judge in USA who believes he can apply his hardline approach to transactions around the world.

The IMF and other international bodies, along with the German-led EU, have taken austerity to a new level, creating very high unemployment and fiscal problems for all indebted countries. This has resulted in some of the normal options being unavailable to national finance ministers, creating political uncertainty and a demand for radical change.

At the same time the United States has seen its currency gain strength and its bond market and stock exchange buoyant. While the Euro has come under some pressure, the European stock markets have been performing very well, with the DAX up over 20% for the year to date.

We have a worldwide system where the rich get richer and, generally, the poor get poorer. The demand for US and EU bonds has been remarkable, based on the enormous issuance of new money by the relevant central banks; what is disappointing is that much of this money has stayed with the banks, rather than being re-purposed to assist SMEs in their funding needs.

On the demand side, USA is creating an improving level of consumer spending, but Europe is still very flat. The other major engine for growth, China, has seen demand reduce – although 7% pa is still a good number overall.

The decline in demand for commodities, in particular for oil, has hurt many developing economies. Nigeria, Russia and Brazil are three large countries with growing financial problems resulting from this reduction, but there many more who are also affected to a high degree.

It is interesting to compare two particular countries and consider how and why they are under the greatest pressure.


There is a fundamental problem with the Euro; the diverging economic conditions between Germany and the Mediterranean countries do not allow the latter to devalue to a realistic level, while Germany is able to feed its export engine with what is a relatively low currency value based on the average for the Euro group as a whole.

The 2014 election in Greece was a clear indication that the people could not tolerate any further austerity. The question is, what can the new government do to alleviate it? The Troika has continued to demand complete subservience and has made little effort to accommodate this situation, not least because any easing of terms would open up demands for similar change in Portugal, Spain, Italy and even France.

Grexit, the withdrawal of Greece from the Euro, is often stated as being the only option; but this does not achieve much if debts are still due in the Euro. This applies to all private debt as well as governmental debt, given the amount of time that Greece has been within this unequal currency bloc.

There is a better alternative; namely an agreement by the Euro member countries to convert all current debt to a long-term, low interest rate merged debt for the 18 countries. Going forward, there needs to be a rolling assessment of the currency adjustment needed to create a fairer valuation and differential between the exporters and the importers. As an example, Germany would suffer a premium fee, of around 50%, on all its sales abroad (whether to other Euro states or externally), while Greece would receive the largest share of this fee, along with Cyprus, Bulgaria and Portugal.

But that is almost certainly not going to happen; at least while Germany is in such a strong position and has no incentive to change the current situation.

The only viable option for Greece is to default on its whole loan book, including allowing private citizens to default on their Euro debt. The impact of the latter is great harm to the commercial banks, probably causing them to fail in turn. Greece would need to have a new currency, preferably electronic, with a way to finance new debt. That will not be easy, unless there is a benefactor to hand.


Argentina has made reasonable strides to recover its economy since the 2002 default, but did need to renegotiate a further loan structure. This was successful, apart from some American vulture funds who have refused to accept the same settlement as all other creditors.

This situation has been made considerably worse by a local judge in New York who considers he has the right to impact all Argentina’s debt matters around the world. In effect, the vulture funds are being protected by this action, which means that any US dollar-based transactions are subject to potential seizure.

The solution, as for Greece, is a total default – but a similar question applies; how to finance subsequent needs?

The financing alternatives

Default is clearly unpopular with existing lenders, and while there are times when this may be viewed as a necessary step by bankers, they are reluctant to risk much new cash unless there is very clear evidence of a change in fiscal conditions. In Greece’s case, there is a need for a new currency to replace the Euro; it is going to be difficult to not reward the many Greeks who have taken large Euro notes out of the country, or have transferred to bank accounts in the rest of the Euro region.

There is one potential supplier of ongoing credit facilities for the time after default who stands out as an ideal partner for the future, namely China. The Chinese economy is still growing, while its current holdings of US government debt alone is in excess of $1,300 billion, so more than capable of investment in both of the needy countries highlighted above – and potentially many more.

The immediate question is whether there is a reason for China to come to the aid of these failing economies. My view is that the geographic position of both is highly desirable for China. A foothold in the Mediterranean, with excellent naval facilities close to the volatile Middle East, could create a useful partner arrangement for both military and commercial purposes.

The relationship with the European Union developing from such an action would be interesting. Would the view in Brussels be that China had solved a problem or, more likely, had created a bigger one with other poor nations also looking to find bail-out solutions?

The one additional country that may be immediately incorporated into such a solution would be Cyprus, closely linked with Greece – and having further valuable geographic advantages. Indeed, if Greece were trying to hold out for too good terms, it is conceivable that a link with Cyprus might be developed first.

Argentina offers control of another shipping route, plus added facilities in the Antarctic. While its economy has often been chaotic, there are abundant valuable agricultural resources.

There are some political factors to also consider. The imposition of legal control by the US judge outside of its borders is clearly unpopular with every non-American. This arrogant assumption of power, as the self-appointed sole Superpower, has caused concern for many countries. While China may be an unknown force, many in the developing world will see the benefit of having an offset to American imperialism.

The other political issue in Argentina is the long-running stand-off between that country and the UK regarding the Falklands / Malvinas. The return of these islands to Argentine control, out of colonial hands, may have an appeal for many around the world.

Would there be any value for China from such an action? That depends on whether the Chinese government decides to expand its role as a world leader. The indications are that this is likely – and if the response to the Asian Infrastructure Investment Bank (AIIB) is to be taken into account, then many will see that as good as well.

The AIIB is the first clear signal of the US’ decline in influence, with many countries, both in Asia and outside, signing up for this Chinese-dominated body against the clear wishes of USA. Indeed, the AIIB creates an excellent vehicle for possible investment in both Greece and Argentina, as supporting trade routes for the Asian countries around the world.

The influence of the AIIB is considered further below, but it may be valuable to also consider three other potential financing sources for these two desperate countries:

Russia: Greece has geographical and religious connections with Russia, as well as newly influential sympathizers within the ruling Syriza party. Russia would like to have an additional access into this part of the Mediterranean, provided on a peaceful basis, particularly if it involved a further ‘bloody nose’ for the EU and the IMF. It would also create some strained relationships for Brussels, with other Member States, many ex-members of the Soviet Bloc, also in lesser but nonetheless difficult financial positions.

Putin is showing himself to be in an aggressive stage of his presidency, whether out of desperation or from a feeling that the West is too disorganized to respond to his military supremacy in the region. There is considerable trepidation in the Baltic States as he sends messages encouraging Russian-speaking minorities to consider demanding further rights within these countries.

Perhaps the less likely scenario is that Greece would wish to choose the risk of a further drop in living standards if Russia became the master – and if they have any choice. Another question is whether Russia feels confident enough in its own financial stability to invest more; the likelihood of that may be measured by whether China provides greater support to its occasional ally in order to help.

That does raise an interesting question; would China support this indirect investment, rather than a direct link into Greece? The potential deniability involved could be attractive, if there were a concern over possible retaliation by the EU and/ or USA in trade terms. However, this seems unlikely to be a factor, not least because of the relative weakness of these two power blocs, but also because of the danger for them of setting off a much larger trade war, which almost certainly China is in a stronger position to win.

USA, indirectly through its hedge fund managers, could also be an alternative financing route. While this would be controversial – particularly if the major US banks ended up losing heavily from the default – it does have some potential for consideration. It could show that the US still has the most financial muscle in the world, If not via its divided government then still from the enormous amount of funds held by Wall Street.

The final alternative is for the EU, or the Euro Zone, to finally accept that default is likely to cause a greater crisis throughout the EU than swallowing up the debt into a central funding source. That would be extremely dangerous for the EU, bringing about much criticism from many Member States, but could be seen as the only action to hold off foreign involvement (particularly if it is seen as being from Russia).

The US and EU alternatives seem the least likely at the moment, because of the political and legal risks involved. This brings us back to a variety of alternatives involving China, and possibly Russia. The concept that has great appeal as part of a “new world order” is if the Asian Infrastructure Investment Bank (AIIB) widens its focus to include trade routes into the rest of the world – through Greece into Europe and through Argentina into Latin America.

AIIB as the new world order for investment

While much is still to be learned and developed regarding the AIIB, what is already established is that it has the power to be an agent for change in the world order. What started as a Chinese-led funding concept to encourage intra-Asian trade and infrastructural development has already grown past that. The other major Asian countries to join include the most important parts of the continent, critically including India, to represent a total population of more than half of the world. What has been even more interesting as a signal to world change has been the applications of non-Asian countries to join, including leading EU members as well as Brazil and Russia.

With USA and Japan as the major hold-outs, the position is becoming more obvious; China has the opportunity if it wishes to make the AIIB its equivalent body of the World Bank, IMF and Asian Development Bank in one unit. Whether China and the other Asian members wish to widen its reach around the world is a key question.

The ability for China to change the economic climate of the world, rather than just adding an additional dimension, is based on a failure of USA and Western Europe to provide a satisfactory basis for development of their own infrastructure, let alone to create a model for Asia, Latin America and Africa. What can we expect to come from the Chinese leadership – and will it be solely financial or is there a risk of military action as well?

The indebtedness of the West versus its ability to pay is of such a level that we have assumed that the old mantra of “if you owe a hundred dollars and cannot pay, you have a problem, while if you owe a million dollars and cannot pay, your lender has the problem” is still valid. That is likely to be challenged by China and the other lending countries, with consequences too great to be fully assessed.

We have a game of bluff played by USA that may be called by China. It has been assumed that all governments are almost forced to hold most of their reserve assets in dollars – and, in that case, the obvious negotiable security is US government debt. But if this changes, imagine what a flow of funds would take place into a different currency or security, based on all the current debt held by China and others.

It is not easy to estimate what would happen to US interest rates if there were even a cessation of further US Treasury debt buying, let alone the sale of some of the current reserves held externally. Yes, the value of all remaining holdings of such debt would reduce rapidly; but is that sufficient reason for this change in investment not to occur?

The reason most quoted as to why China would not play this card is the difficulty in managing such a large inflow of funds that would happen if the RMB became the second reserve currency. That argument has merit, but a different scenario is now available; what if the money flow was into the AIIB as a blend of all the Asian member countries’ funding?

It is not my plan to attempt to cover all of the issues which could develop from such a change in this brief memorandum. Indeed, it would be almost impossible to assess all the variables that may occur. But what we should do is start to plan for the possibility, before it is too late.

The EU will perhaps give an early warning of what could happen to USA if it continues with its current policies. The Euro is a fragile creation, which is both violently over-valued and under-valued at the same time depending on the Member State. It would be best if the Greek situation was brought to a head, rather than kicked down the road again – but which answer would they come up with?

As a last point, the UK is preparing for an election which has all the signs of creating a political turmoil from which there are few good outcomes. How this can impact the EU, and from there the rest of the world, is a point for another commentary.

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