Should Greece Default?

27 September 2011


Letting the Market Mechanism Take a Back Seat

January 2011George Papandreou, Greek Prime Minister

“Greece won’t default.”

June 2011 – Jamie Dimon, J.P Morgan C.E.O.

“Greece won’t default.”

September 2011 – Klaas Knot, European Central Bank Governing Council member

“I’m not saying that Greece will not default…I am now less definite in excluding a default bankruptcy than I was a few months ago…”

In terms of locale Greece is certainly far away from us here in the Caribbean, but thanks to contagion, the risks attached to a Greek default may be closer than you think. Market correction is always painful (1929 and 2008 should evoke enough misery), but throwing money at a problem doesn’t seem to be the answer. The U.S. is quickly learning this in the face of bank downgrades, the lifting of the debt-ceiling and the latest manifestation of QE…I mean “Operation Twist”. Even if an orderly default is implemented, surely this action has come too late: Euro-zone (sovereign and corporate) bailouts, defaults and downgrades are almost glibly used.

So the real question is; what happens when the “troika” of the EU, the International Monetary Fund and the European Central Bank decides to take the training wheels off?

Let’s take a look at these effects in relation to three broad issues; Euro-currency effects, potential buying opportunities during crisis, and the probability of a Greek recovery. As we approach another financial year-end, those of you with euro-denominated or euro- domiciled investments should certainly look at the effect of mark-to-market losses (both current and expected). I won’t be surprised if several financial institutions dedicate a section to the impact of euro-zone distress on their balance sheets.

September 23rd, 2011: Amid rumours of a report by Greek Finance Minister Evangelos Venizelos regarding an orderly default which may result in a 50 percent haircut for Greece, euro/dollar is trading just above its lows and liable to break through there again if there is any more bad news,” said Kit Juckes, currency strategist at Societe Generale.

Imagine what happens when a default is confirmed and officially implemented!

A quick joke to lighten the mood amidst all the depressing news:

Two men see a cow stuck in a ditch and argue over which one should claim it. Who do you think wins between the two men trying to pull the cow out, the man trying to pull on the tail or the other pulling by the head? It doesn’t matter! While they fight at either end, there’s a lawyer mediating the dispute and milking the cow!

Greece is certainly ‘stuck in a ditch,’ a deep one at that, so who is ‘milking the cow?’

Chancellor Merkel & Co. surely realise that forgoing a weaker Euro for their stronger Deutsche Mark would negatively impact German exports. This, in addition with a vested interest in the Greek banking sector can rule out any humanitarian justification for continued support. So if the Euro is here to stay, why not look at cheap pick-ups within the region? The adage of “Buy in weakness and sell in strength,” has hardly been more salient than in these times. I suggest you all stay tuned… booms and busts are here to stay.

That brings me to Greek’s chances of stabilisation and/or recovery in a hypothetical post-default era. First, some key stats:

  • After contracting in 2009 and 2010, GDP fell by a further 7.3% in the second quarter of 2011.
  • Unemployment is approaching 900,000 and is projected to exceed 1.2 million
  • The budget deficit for 2011 is on course for 10% of GDP, when the target was slightly above 7%
  • The debt-to-GDP ratio could reach 200% in 2013, up from 115% in 2009

While there is fear that Greece may be effectively locked out of the markets for some time, one source indicates that any growth penalty from a default tends to be short-lived. Argentina saw its GDP decline by 10.9% in the year after its December 2001 default. This is by no means encouragement to default in order to boost long term growth. However, Greece has been bankrupt since 2010 (if not earlier) and the economic situation has only worsened since.

Socially, there are reports of entire communities being unemployed, reversion to barter, rapidly deteriorating medical and education systems, and abandoning cities to return to agriculture, a sure sign of social retrogression.

To provide balance to those who are pro-default, though, experiences vary widely. In our very own region, Grenada, Belize and the Dominican Republic, have fared poorly after defaulting, but that is not to say better or more equitable measures were available (see charts below). Debt-to-GDP figures help to paint a clearer picture with regards to default; with Dominica reportedly at 72%, and Jamaica and St. Kitts& Nevis well above 100%. These three countries have experienced defaults and Greece has a 2012 projection of 189%. Surely you have an idea of where I’m going with this?

It wouldn’t be fair to close on the topic without at least highlighting how severely a default would affect global markets, hence the need for prolonged talks on the issue. But, as I said, keep careful watch! This final quote should crystallize the severity of the situation:

Greece is “on a knife’s edge,” German Finance Minister Wolfgang Schaeuble told lawmakers at a closed-door meeting … If the government can’t meet the aid terms, “it’s up to Greece to figure out how to get financing without the euro zone’s help,” he later said in a speech to parliament.”

We can hardly afford another few years of diminished investor confidence (I can’t blame you for losing faith), but rather than remain trapped by circumstance, make it work for you! Manage expectations, enjoy the yields when available, and sit tight.

Gerard Stephens
Account Executive Sales

References:

http://www.economist.com/blogs/dailychart/2011/06/sovereign-defaults-and-gdp

http://www.guardian.co.uk/commentisfree/2011/sep/19/greece-must-default-and-quit-euro

3 Responses to “Should Greece Default?”

  1. Senyela says:

    This blog made good reading. I have a colleague who has Greek bonds in his portfolio. Do you think he will get a buyer now or should he hold them for a little longer?

    • Gerard says:

      It’s difficult to call that one @Senyela, this morning’s successful German vote to expand the EFSF (European Financial Stability Facility) gave global markets a temporary lift (aided by lower jobless claims in the US), but we’re seeing some of those gains erased in the later trading hours.

      The only definitive advice I’d give is to keep careful watch of the news coming out of the region. A hint though…today’s vote should signal the unwillingness of Germany to let a disaster happen which would disrupt the entire European Union.

  2. Keith M King says:

    Greece will default. The only debate is the timing and extent of the haircut that has to be borne by holders of Greek assets. Hopefully most investors would have taken the couple years of this denoument to provide for the writedown.

    Germany will likely have to bear most of the pain as they have benefitted most economically from the European Union and probably have most to lose if there is a disorderly breakup.

    Unfortunately the rest of the world, and in particular the financial markets, will also be hit when the actual shock impacts.

    The faint of heart should stay in cash or near cash. The world as a whole also needs to adjust to low yields going forward. High yields mean high risk, declining asset values, whipsawing valuations. It may also mean great opportunities for those who have the courage of their convictions to stay the course in the midst of the mental terror of asset volatility sometimes exceeding 15% in one day!