Insights & Advice


Why Greece Matters to You

Why would a country about the size of Alabama with a population less than a third of California’s matter to you? Yet, the lowering of Greek’s sovereign debt rating to “junk” status on Tuesday drove world stock markets down by over 2%.

I figure that rating change by Standard and Poor’s Rating Services lobbed a$1 trillion off the world’s markets and probably put a small dent in your retirement savings this week. Unless Europe gets its act together soon, expect more of the same in the months ahead.

In a nutshell, Greece is Europe’s Lehman Brothers. Thanks to years of proliferate public spending (their public sector accounts for 40% of GDP), low tax collections and sub-par economic growth, the financial crisis clobbered Greece when it could least afford it. And unlike other countries, its economy is not recovering. Analysts expect a further decline of 3% in GDP after a 2.5% drop in 2009. That’s not good news for a country which already has the largest external sovereign debt to GDP ratio in the world.

Greece owes money to everybody. Banks throughout the world are on the hook for billions, especially in France and Germany. Greece can’t pay and for months now the European Union and the International Monetary Fund have been dickering over the terms of a bailout. Part of the problem is attitude.

Like the sentiment in our own country in 2008 that dictated that we just let Lehman Brothers go under, the citizens of several European nations, notably Germany and France, feel the same about Greece. The majority of the German population, in particular, is opposed to a bailout. As a result, Chancellor Angela Merkel is taking a hard line against a bailout of Greece or any other Club Med nation. Herein lies the rub.

The problems of Greece are also present in several other nations along the Mediterranean Sea including Portugal, Ireland, Spain and Italy. Investors rightfully fear a contagion effect if sovereign debt issues in Greece lead to bankruptcy and similar problems arise in Portugal, Spain, Ireland and then Italy, until all of Europe and possibly the world are engulfed in a second financial credit crisis.

And while Greece and Portugal are comparatively smaller economies, Italy and Spain are the world’s eight and ninth largest economies. Just this week, Standard and Poor’s appeared to confirm investor’s fears by not only downgrading Greek debt once again, but also reducing both Portugal and Spain’s sovereign debt ratings as well.

Remember that the Federal Reserve and the U.S. Treasury’s decision to let Lehman Brothers go under triggered the first financial crisis. Lehman’s failure caused big problems for several large U.S. banks, as well as insurance companies and brokers. The mega-billion dollar bailout of AIG, for example, was a result of a chain reaction of broken debt covenants brought on by the demise of Lehman Brothers.

This time around, the ball is in Europe’s court and how they handle Greece will have severe repercussions on our financial system, which is recovering, but still far from healthy. Both U.S. and Asian banks and other financial institutions hold substantial debt in European countries and companies. According to the Bank of International Settlements, foreign bank exposure to Greece, Portugal and Spain alone total $1.6 trillion.

And unlike the United States, where one government can make decisions comparatively swiftly, the European Community is just that—a community of 27 nations with different goals, objectives and competing interests. So far, between the IMF and the EU, a 45 billion Euro bailout package has been tentatively approved. It is the least amount of money that will suffice to pull Greece from the brink of bankruptcy, according to economists, but not enough to really solve its problems. To do that, the IMF’s Managing Director, Dominique Strauss-Kahn, said Greece will need as much as 120 billion Euros in aid.

During our own dance at the edge of the financial cliff, the Fed and Treasury quickly realized that a piecemeal approach to solving our sub-prime crisis wasn’t going to cut it. Instead, we threw trillions of dollars at the problem and it still took almost a year to pull back from that precipice.

It does no good to demand that Greece “get its house in order” in exchange for a stop-gap amount of money that won’t solve that nation’s economic issues. Clearly, it makes no sense to cut spending, increase taxes and require an onerous austerity program to a country that is already reeling economically.
Back in the 1990s, I remember the IMF demanding the same kind of programs in exchange for aid to emerging market nations. Those that took the money and followed the IMF’s prescription ended up sending their countries into an economic free-fall that led to social unrest and revolutions.

I believe a far more comprehensive approach is in order in Europe, one that includes other nations that have similar economic problems to Greece, specifically Portugal, Spain and possibly Ireland and Italy. Sure, it will cost money, money that the more developed European nations do not want to spend given their own extended balance sheets and recovering economies. Yet, the alternative would be far more expensive in the long run. These issues would create a long-term drag on the economic prospects for the European block, weaken the Euro and possibly drag the rest of the world down with it.

Either provide a bailout package that would truly address the needs of these nations or allow them to formally restructure their debt. That would mean essentially de-faulting on their debt, dropping out of the Euro-zone for a year or three while they get their act in order without Typhoid Mary’s austerity program, and then re-join when the time is right. Plenty of nations have defaulted on their debt and came back to bigger and better things. Of course, the European community may endure some embarrassment and a bit of egg on their jowls, but it beats the alternative. Europe, it’s your move and for our sake, get your house in order!

Posted in Macroeconomics, The Retired Advisor