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Friday, May 7, 2010

The Europeans Need a New Grecian Formula

The Europeans Need a New Grecian Formula:
The One They Have is Giving Me Grey Hair

May 7, 2010. With the maximum overdrive market movements of 05/06, it’s not surprising that I never thought I needed to be concerned with Greece, but now I do. The Greek market has created so much consternation, it caused an overstressed trader to hit a ‘B’ instead of an ‘M’ and set the market on a Cedar-Point like roller coaster ride. Mad markets make for interesting times, but remember that ‘interesting times’ is a Chinese curse.

Let's put this in perspective: Greece is somewhere around 27th in world GDP. Their debt has ballooned from about $30B (I do hit the ‘B’ correctly) in 1990 to about $442B now. (Little less, because the Euro has fallen). When Greece joined the Euro-zone, they agreed to keep their budget deficit to 3%. Of course, that really didn’t happen: Their deficit actually is 13%. Why? They have large expenditures for a variety of social programs; they have a pretty robust Greek pension system (for example one of the reforms they have is to move their retirement age from 61 to 63.), and in general don’t collect their taxes. They’ve agreed to cut costs and reduce corruption. The labor unions don’t like it, and have been striking (who wants their retirement age increased and their taxes increased?).

There is not only doubt over whether the Greece austerity plan will work, but whether the Greek debacle will spread to the rest of Club Med (Spain, Portugal and Italy; Ireland is not on the Mediterranean, but I like the Irish and they have a laid-back Mediterranean attitude, so I’ll lump them in as honorary members). The spread on Greek debt is at all-time highs. On May 6, the EU basically agreed to an austerity plan to get Greece into compliance with the 3% deficit by 2012. An interesting part of the package is that Portugal signed on to loan Greece money at rates lower than they can borrow, which is kind of like Detroit borrowing money to bail out California. We’ll see if it works. I have two versions: a) this is a band aid that will cover the wound long enough for the whole Euro-zone to heal a bit; or b) this is another Argentina-type debacle and the EU is throwing good money after bad.

I’m hoping for a) and I think the market is looking at b). All the while the market, now focused on something bad to look at, is ignoring the headwinds of corporate profits, better than expected jobs number, a real estate market showing signs of life, and no immediate signs of inflation. In my opinion, more tailwinds than headwinds.

Making a government entity responsible for its books and balancing its budget is appropriate. Having citizens pay their taxes is reasonable. Stopping a country from running up debt in excess of its GDP is prudent. Hmmm… maybe it’s something we should try as well.

Ta léme argótera

Leon

PS: Greece has defaulted or rescheduled its debt 5 times since 1829, and Reinhart and Rogoff point out that Greece has spent 50.6% of the years from 1829 in default or rescheduling. Don’t ignore history.