The topic ‘du jour’ in financial markets remains Greece, and the possibility of either debt default, exit from the Eurozone, or both.
Greece continues to negotiate with its major creditors with the focus of the “covert” discussion focused on increased taxes and lower pensions. Greece’s economy minister, Giorgos Stathakis told the BBC, “We [will] try to remove the tax burden from pensions and wages towards business and the wealthy”, he said the proposals also included an increase in the VAT rate for some selected items.
However, the negotiations do have a farcical element as they have now endured for some four years. A “slow motion train wreck” – dare we use those words – is presenting itself. However, it is not the train wreck that markets are concentrating on. Rather it will be the breaking down of the Greek social framework that we should be focused upon.
Too much is made of the capital markets response. What will currencies, equities and bonds do as events unfold? Seriously if anyone is not prepared for whatever happens in the next few weeks then they are clearly living in an alternate paradigm. In any case and importantly, the European Central Bank (ECB) waits ready to stabilise markets with a massive Quantitative Easing Program. After seven years of relentlessly bailing out Europe, the ECB is not going to let Greece derail things.
The next big date is 30 June when the IMF is hoping to receive some 1.6 billion euros from a Greek Government who has no money. If the loan is not paid then the IMF will not declare default but rather will claim the loan is merely in arrears and the game roll on through the European summer holidays.
In a remarkable and hypocritical turn of events the ECB is now pumping billions of euros into Greek banks so they can meet withdrawals at the same time as the IMF is negotiating to take money out of Greece.
This farce is a clear example of why we should not let bankers and bureaucrats try to solve a problem that they created.
Is Greece’s troubles as important as many investors think?
From a macro perspective their situation appears dire, with unemployment over 27% the government’s ability to generate tax revenue is severely hampered. Debt levels remain high at over 146% of GDP, with no improvement in sight with forecasted fiscal deficits and the burden of debt repayment intensifying in the face of a deflationary environment (-1.43% CPI in May).
However, when we take a closer look at the fiscal position, it appears that the Greek fiscal position has improved in recent years. It now runs a “primary surplus”. This occurs when government revenue is sufficient to cover expenses excluding interest. In layman’s terms that means that Greece can service a Harvey Norman loan – No interest and no repayments. However, a primary surplus means that debt will not rise. Unfortunately if the economy contracts under austerity then debt will rise as a percentage of GDP.
This means that if debt will have to be forgiven or compromised as part of the solution and frankly it probably already has been.
While the possibility of outright default appears confronting from an Australian perspective, in a historical context this is nothing new for Greece. As illustrated in Reinhart and Rogoff’s, This Time is Different: Eight Centuries of Financial Folly, Greece has been a serial defaulter over the course of history. Since gaining independence in 1829, Greece made up for lost time by defaulting on external debt four times (1826, 1843, 1860 and 1893) before reaching the twentieth century. During the twentieth century, Greece defaulted again in 1932. All of this folly accumulates to quite a remarkable statistic: in the 179 years between independence and 2008, Greece spent 50.6 years in either default or a state of debt restructure. Not to forget the two banking crises before 2008 and the period of hyperinflation peaking in 1944 which was regarded as a default event through currency debasement.
When we reflect on history we see that Greece has never dragged the world into a financial crisis even though it is constantly in one.
As investors, we need to sift through the noise. In our view, a collapse of the Greek economy is in no-one’s interest and we doubt the ‘Trioka’, the European Union (EU), European Central Bank (ECB) and International Monetary Fund (IMF) will let this happen. The insolvent nation is relatively tiny and its bonds have been well protected by the ECB.
The more important trend is the gradual journey of European bond yields back towards ‘normal’ levels after recent unsustainable rates around or below zero. Not to mention, the plight of the Greek people who look certain to endure near depression type conditions for the foreseeable future.