Friday, April 23, 2010

Greek Tragedy Moves Closer to Final Act

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Greece has finally requested an activation of a proposed EU-IMF $60 billion aid package. Negotiations on the terms will be taking place over the next several days. Currently it looks like Greece will be loaned the money at a five percent interest rate. This is more likely to delay default rather than prevent it.

Events on April 22nd finally forced Greece's hand. Moody's downgraded its sovereign debt to A3 from A2 and placed it on credit watch for a possible further downgrade. At almost the same time, the EU Statistical Agency revised Greece's 2009 budget deficit as a percentage of GDP to 13.6% from a previous estimate of 12.7%. The markets reacted negatively with yields on 10-year Greek government bonds rising to 8.7%. Spreads between Greek and German debt rose to 5.6%. Credit default swaps, which are bond insurance, rose to a very high 650 basis points. The euro (FXE) hit a fresh 11-month low of 132.55 against the U.S. dollar.

How much will loan support from the EU and IMF really help Greece though?  The aid package provides enough money to tide Greece over into some time in 2011. Greece has not been having trouble borrowing money, but the trouble is paying high interest rates on the money its borrows. Would 5% be low enough to not seriously threaten Greece's attempt to reduce its budget deficit?  The answer is probably not. Greece, like many countries before it, has entered a downward spiral where debt default becomes inevitable without massive ongoing bailouts. Attempts to balance its budget will severely damage its economy, which is heavily dependent on government spending (as is the case for many other countries including the United States). As it cuts spending and raises taxes to reduce its budget deficit, its GDP will also decrease. A lower nominal budget deficit with lower GDP, means the percentage of the budget deficit to GDP may not decline that much despite extensive efforts to make it happen.

While it looks like Greece's problems happened overnight, they did not. Greece made efforts to hide its fiscal problems for at least a decade. Its most recent endeavors included simply lying about its budget numbers. The fibs it told were so outrageous that if Greece had been Pinocchio, its nose would have stretched across the Mediterranean. Nevertheless, the EU Statistical Agency accepted them without question. It was Greece itself that revealed the scam as it was falling apart. Pervasive lying with statistics is a common last phase before a fiscal collapse. Americans may want to take a close look at the GDP, inflation, and employment numbers produced by the U.S. government as they ponder this thought.

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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