The whole world is carrying too much debt. Years and years of artificially low interest rates, lax lending standards, and a belief that assets can't fall have clogged our arteries with bad investments and unserviceable debts. We had a heart attack in 2008. It hurt, but it didn't kill us. We should have learned from it. Instead, we ordered the world's biggest plate of pancakes and bacon. We took on another huge slab of debt and we supported all the malinvestments. Greece's problems are like chest pains after you've just left the hospital. They make your family nervous... Given the massive debt levels, investors are demanding a very high rate of return at 7% because the risk of default is high, compared with 4.5% a few months ago.. If Greece is not able to raise capital, it won t be able to meet its obligations.
If Germany bails out Greece, it just makes the problems in Europe worse. Greece stops trying to fix itself, and now every other broke European country knows they can have a bailout, too. They also stop austerity measures. And meanwhile, the debt burden is still there. It hasn't gone away. They've just pushed the default farther into the future.
Greece, in other words, is the fiscal Petri dish that reveals in gory detail what could happen if soveriegn governments fail to maintain the confidence of investors. It is not merely that those interest rates are already inflicting an awful toll on borrowers in Athens and beyond. It is that they are sending the national government towards a full-blown debt spiral, in which the cost of its annual interest bill becomes so unmanageable that it can hardly afford to supply its citizens with basic services.
But on the bigger matter of what this euro collapse country by country means: in the usual sequence, if Greece were still using its own drachma, the world would write down the currency, devaluing it in exchange terms. The holders of Greek bonds would take a big capital loss and the system would eventually regain a better trade balance as Greece wouldn’t be able to afford to import as much at the same time that exports would increase thanks to cheaper labor. But with the European Union in place, the exchange rate can't move, so Greek interest rates have jumped.
Greece is not a major economic power. It only represents 2% of Europe s GDP. The market is paying close attention to this situation because Greece is a microcosm of Europe. Many other nations are in a similar situation (Portugal, Ireland, Italy, Spain, Bulgaria, Latvia, Lithuania and even the United Kingdom). Enormous debts have resulted from liberal social programs (national healthcare, pensions, welfare) and many governments have been spending beyond their means for decades. A year ago, they were not in a financial position to spend billions of dollars on bailouts and stimulus programs but they did. Now, they are dangerously close to the breaking down completely.
The situation in Greece might be resolved in the next two weeks, but the next problem is just around the corner. Last week, Portugal tried to raise $1 billion in a one-year auction and they had to cancel it due to low demand. When a country can t even auction short-term maturities, it is in dire straits. Spain s unemployment rate is 19.5% and their debt has been downgraded. Spain is a much bigger problem as the country represents 13% of Europe s GDP. All countries are struggling with their own deficits and they can t jeopardize their own well being to help other nations. The dominos are lined up and wobbling, and almost anything – even a concerted push by speculators – could set them in motion. It seems to me that the euro is turning out to be much more complex to manage than the US dollar and could be very vulnerable for years to come.
To play offense, you can short the Euro ETF "ProShares UltraShort Euro" (EUO:NYSE). Block-tackling through defence, consider going switching to US Treasury bonds as a safe haven this year.
US Bonds: a safe haven to diversify away from the PIGS (but for 2010 only) ...
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