You can’t go to a financial website or watch financial television without seeing a headline about the huge problems facing Greece. This is a tiny country of 11 million people and a total GDP that is less than the market capitalization of a number of American companies. Greece’s problems are similar to those facing most of Southern Europe but the starting deficit in term of debt to GDP was worse, due to inaccurate reporting from the government. Greece also has an extremely difficult political situation that was exasperated this year with the election of a truly radical political party that campaigned on changing the bailout agreement with the EU.
While much of the news media seems to take the side of the EU, it is important to understand the current conditions in Greece. This country is in a state of depression not unlike what the U.S. and Europe saw in the early 1930s. Prior to the establishment of the Euro currency, Greece would have printed Drachma to help repay debt, which would have depreciated the currency. The depreciated currency would bolster both exports and the immensely important travel industry, likely beginning a new phase of economic growth. This is exactly one of the steps that Japan is taking to deal with its slow growth economy and extremely daunting debt load. Unfortunately for Greece, the Euro is bolstered by the economic strength of Northern European economies such as Germany, France and the Netherlands, so depreciating the currency isn’t an option.
While the Euro is good for most European countries if all countries abide by the rules, which has certainly not happened, Northern Europe is a bigger beneficiary. Most of those stronger economies are more export-driven, so they benefit from having a currency that is likely weaker than what their own individual currencies would have merited in the old system. These countries are incentivized to help Southern Europe out with loans to ensure the long-term viability of Europe.
A major problem is that the EU is not a political union but instead is merely an economic union. The United States faced similar issues prior to Alexander Hamilton spearheading the effort to consolidate all of the debts of the individual states. In this case Germany is a major proponent of austerity due to the traumatic impact that inflation had on the country after World War 1. Greece and much of southern Europe is riddled with entitlement programs, which are extremely painful to cut into. Austerity sounds great, but cutting government spending and raising taxes, without drastic improvements in efficiency, is going to lead to reduced economic output. Greece is horribly inefficient, so the impact has been that much more devastating.
The reality is the Greece cannot survive in the EU without additional debt forgiveness from its creditors. They can’t cut their way to solvency. The Greek government must make concessions to creditors as well, which will surely draw the ire of political rivals threatening their existence. Most Greeks do want to stay in the EU though, so a default could very well begin a political process which removes the current government from power. I believe that both sides will draw this out until the very last minute. Deadlines will come and go, as political posturing that both sides need to convince their constituencies to meet in the middle. Germany would face massive losses on Greek bonds if Greece defaults. They are very much aware of this and so deep down there has to be some willingness to either reduce principle, lower interest rates, and or extend debt maturities. These restructuring activities could very well lead to a more favorable result for the creditors than a Greek default at this point. The problem on both sides is politics of course.
Fortunately, the ECB has the ability to contain the crisis no matter what happens with Greece. The other troubled countries have been much more proactive than Greece and are in better financial condition. If their bond yields increase as a result of a default, the ECB can buy them aggressively to reduce them. Most banks in the EU have unloaded their debt to the ECB, so it is the countries themselves that will bear the brunt of the losses, as opposed to the financial system. This should reduce the contagion risks in the worst case scenario.
As far as TTCM goes, we have no direct exposure to Greece. We own one European bank, which could be slightly impacted, but the risks are more than priced in and I certainly wouldn’t be too concerned about it. There will be a lot of drama and perhaps significant volatility as this situation works itself out, but the long-term impact on your investments is unlikely to be too significant. If you have any questions, feel free to give me a call but I just wanted to shed some light into the current situation.