It surely isn’t the best way to end a financial year however the focus on Greece is not something new and has been going on since 2009 when the European Debt Crisis emerged. We have put this together with thanks to the research team at PATRON Financial Advice and Infocus Wealth Management.
The European Debt crisis started near the end of 2009 almost a year after the US investment bank, Lehman Bros, collapsed on September 15th 2008.
When house prices started to decline in the US in 2007, there were ramifications for some of Lehman’s products – and these impacts snowballed as investors realised that they didn’t understand who owed what and to whom. Credit markets seized up and the US Treasury stepped in with a number of bailout programmes was the Quantitative Easing (QE) programme that started in late 2008 and ended in October 2014.
The US started its reducing the QE programme in December 2013 meaning that it was still pumping funds into the system but at a progressively slower rate. Market volatility occurred because no-one really knew what it would mean for markets.
The US Treasury bailed out many US banks but most, if not all, have since recovered and paid back their Treasury Loans with a profit to the taxpayer. It is unimaginable to think what might have happened without this bailout. Even the 1929 Depression would probably have looked like good times in comparison.
Some commentators say that QE didn’t work because the US economy is not back to full strength. This is a silly comment in the extreme because the comparison must be against what the US economy would have been like without QE – and no-one can be certain what that would have looked like. In the Great Depression on the 1930s images of men jumping trains to criss-cross the country in search of work abounded, soup queues were long, etc. If that or worse would have happened without QE then QE was a resounding success. US unemployment has fallen from over 10% in 2008-9 to about 5.5% in 2015. US government debt stood at around $4.5 trillion dollars after QE finished.
In 1992, the Maastricht Treaty bound European members to control fiscal management (government debt management) responsibly. During 2000 – 2008 some member countries started to structure their debt in a manner, and possibly with a purpose, similar to that of Lehman Brothers. As a result, the true debt positions of member countries were not transparent.
When the European Crisis started in late 2009, four countries, collectively called the PIGS (Portugal, Ireland, Greece and Spain) we all love a good acronym, were singled out as being particularly problematic. Some people included Italy as the fifth of the PIIGS. Debt-to-GDP levels were uncomfortably high and the PIIGS needed some sort of financial bailout.
The so-called ‘Troika’ (European Central Bank [ECB], International Monetary Fund [IMF] and the European Commission [EC]) provided its first bailout to Greece on May 1, 2010 (110 billion euros for 3 years) in return for certain ‘austerity’ measures. Similar measures were attached to the other PIGS’ bailouts. Portugal, Ireland and Spain have each successfully exited their programs in 2014 and their economies are starting to get back to normal. The UK – which does not use the euro but had some fiscal issues – voluntarily adopted some form of austerity under the Conservatives and now has one of the strongest economies in the developed world. David Cameron was recently re-elected for another five years on that result – and this time with a majority government.
What is the state of play today?
The Greek Prime Minister resigned in November 2011 because of the unpopularity of the austerity measures adopted in 2010 and he was replaced by an interim Prime Minister who tried to co-operate. Syriza – anti-austerity party – was elected to office in December 2014. They have played hardball in negotiations and so have the creditors. Greece is almost certain to default on a $1.7bn payment to the IMF due on June 30th. Another payment of around $8bn is due on August 31st. That looks unlikely to be paid too.
Greece was the first country to ever default since 377BC! Since independence in 1829, Greece has been in default about half of the time. However, the previous currency – the drachma – could devalue to help the country’s economy adjust. Since it is now part of the eurozone, it cannot devalue its currency without leaving the euro and possibly the EU.
A referendum is to be held on Sunday July 5th with Yes and No the only possible answers to the question of whether or not to adopt austerity. Nobody in the world wants austerity for him or herself but the Greeks apparently want to stay in Europe and that means accepting austerity. The Europeans also want Greece to stay in the eurozone. A new government may well have to be formed after the referendum and that could buy negotiating time.
The Greek Banks are closed – but everyone has had so much warning to squirrel away money – even in other countries. The Greek stock market is closed at least for tonight. There is a 60 euro limit per day on withdrawals from ATMs.
Why did our stock market go down?
Our market opens and closes before Europe the US. Therefore, uncertainty typically induces a sell-off until major markets are observed. Remember when the US lost its AAA rating on Friday August 5th 2011? We lost ‑2.9% on the day. That night, Wall Street lost over ‑6% and we opened on Tuesday with an early loss of over ‑5% but we finished up +1.2% on the day!
What is the big issue with Greece?
- It is not a default, per se.
- Since independence in 1829, Greece has been in default about half of the time.
- Notable recent sovereign defaults: Mexico (1982), Brazil (1990), South Africa (1993), and Argentina (2002, 2014). Most people with no personal contacts with those countries probably didn’t notice anything following these defaults!
- It is not its size!
- Greece GDP is about 1.3% of the European Union’s GDP.
- Its population is about 11m and (reported) per capita income in Greece is about half of that of Germany or France.
- It is not the same as 2010!
- Back in 2010, many banks and investors across Europe and elsewhere were exposed to Greek Banks and their debts.
- A collapse in the Greek Banking system in 2010 would have had a knock-on impact across Europe and the rest of the world – called contagion – just like Lehman’s collapse.
- Since 2010, these exposures to Greek banks have largely been transferred from other banks and investors to the European Central Bank (ECB) – and the ECB is big enough to handle it – just like the US is handling its $4.5 trillion debt.
- The other PIGS countries (Portugal, Ireland and Spain) successfully exited their bailout programs in 2014 after taking their medicine starting in 2010. These economies are starting to recover.
- It is the fact that Greece will not agree to the conditions attached to further bailout – the so-called ‘austerity’ measures as Portgual, Ireland and Spain did.
- Greece will almost certainly default on its 1.7bn euro payment to the International Monetary Fund (IMF) on June 30th 2015.
- Greece will almost certainly default on its approximately 8bn euro payment due at the end of August.
- The July 5th referendum might go either way. Greeks seemingly want to stay in the euro but do not want austerity. If it doesn’t accept austerity it might be forced out of the euro.
- It is still possible that creditors might make some arrangements that avoid a Grexit (a Greek exit from the euro) but they would be foolish to show their hand until all else has failed.
Why is ‘austerity’ such an issue in Greece?
- The sorts of issues being examined for Greece are:-
- Increasing the retirement age from, in many cases, from 50 to 65.
- Applying GST not just to the mainland but also the island businesses.
- Enforcing income tax payments. Some say ‘tax dodging in Greece is a national sport’ when I was last in Athens in 2008 I was surprised to see all these houses with one room not completed. I was told by a local this was to avoid paying land taxes as the property was not yet completed…
- Since some benefits, such as those for unemployment, end after a year, it is argued that age pensions have to support whole families. Aged pensions are not the solutions to a youth problem.
- It is hard to change entrenched behaviours.
- The Greek economy only really has tourism and shipping as major industries. Like Ireland and other agricultural economies, Greece received big subsidies on entry into the European Union (EU). Unlike Ireland, it seemingly didn’t use entry into Europe to create new industries and businesses. Indeed, Ireland has become a ‘poster boy’ example of good economic management in recent years.
What if Greece exits the euro?
- If Greece had never joined the euro, we would not have noticed the difference!
- Eurocrats have had two to three years to get ‘Plan B’ in place, even if we haven’t been told what that plan is.
- There is a loss of face for the EU if there is a Grexit and a small fear that some other small countries might wish to leave.
- Portugal, Ireland and Spain have no real reason to leave the euro now – but they may have done so in 2010 if Greece had been ejected.
- There will be short-term volatility in many markets – particularly those more closely aligned to Greece. But there is no reason for a long-run deterioration in conditions in the major European countries, Australia, US, China, Japan etc. It is basically a Greek problem.
- If Greece goes back to the drachma, there could be major ramifications for the relative wealth of its citizens. When Iceland was forced to break its ‘peg’ against the euro following its bankrupted financial system, its currency devalued by about 35% in 9 months. Typically countries reduce their debt problems by inflation and devaluation. In effect, that is what the US has done since 2008.
- A devalued currency makes imports more expensive worsening conditions for Greeks.
- Exports should benefit from a devaluation of it currency, but tourism – its major export – may not respond to cheaper holidays as before because of possible political and social unrest.
- Greece might find it much more expensive to raise capital in the future from selling government bonds because of the perceived chance of another default.
As always diversification is key to any successful portfolio approach with a long term view.