Could Grexit be just around the corner? The European Union is on the verge of losing its first member

publisher
Grexit

Grexit

For the last 6 years, Greece has been a country burdened with bad debt and the threat of default on loans that will take more than a few generations to pay back. During that time, the economy has failed to improve, and again Greece is potentially on the verge of defaulting on its loan obligations, and leaving the European Union.

Two years ago, the threat of a Greek Exit from the EU (referred to as Grexit), sent the stock markets into a mild panic. Volatility increased and investors were jittery. Any minor news headlines triggered investors to sell their shares in fear that another Global Financial Crisis (GFC) would send markets plummeting. This time around, investors are complacent. Why?

In 2009, Greece’s international credit rating was downgraded as it was deemed the government would default on its ballooning debt. This resulted in severe spending cuts that the economy has simply not recovered from.

Greece wasn’t the first country to succumb to a debt crisis, however. In fact, over the last 100 years, there have been no less than 83 countries who have defaulted on their economic debt or required debt restructuring. And we’re not talking countries that are so small they barely have a government to run them. Countries such as China (1921, 1932, 1939), Germany (1932, 1939, 1948), Brazil (too many times to mention, but more recently in 1990), Russia, Sweden, Turkey, Poland, and the list goes on. Of course, most of these examples revolved around global wars or following conflicts.

Why does a country create debt?

The simple answer is to fund government operations and expansion. The revenue generated internally within the country’s economy may not be sufficient for it to maintain a standard of living, or even grow. Therefore, the country raises capital either through internal debt or external debt. Both might be through issuing Bonds or Securities or even selling off Assets, or it might be through international organizations such as the World Bank or International Monetary Fund (IMF).

Citizens of a country have expectations that the government will support the community and provide an environment that is safe and prosperous. Taxes and other revenue streams will fund most of this, but if there is an economic downturn and the government does not have the means to fund continued growth, then they will look towards other means to raise capital to assist in helping the economy.

Much of the debt is held with the country’s very own Central Bank. The Central Bank is a separate, independent body to the government. It is usually privately owned and operated, in most cases by banks and bankers.

So what ends up happening is that when a government borrows from their central bank, it will have to pay interest on the loan. The Central Bank is not going to Risk lending money to a government without having a reward. And just like your home loan or car loan, the Central Bank would prefer that you never pay it off but continue paying interest as it is how they make their money.

For most countries, they are constantly paying interest that is compounding on itself and the debt is continually getting bigger. Until such time as the government cannot actually pay the interest on the debt, and they default. Basically, the country becomes bankrupt.

Can’t pay your debt? … Bailout!

In 2010, Greece was on the verge of defaulting on their debt repayments. Even after reducing spending, the threat of default was imminent. Eurozone countries, the IMF and ECB (European Central Bank), referred to as the Troika, approved a $145 billion USD rescue package. To date, the bailout total has amassed to 240 billion Euros.

Further spending cuts occurred. Referred to as Austerity Measures, the government was spending less and less, but citizens were struggling more and more. Unemployment skyrocketed and protests lead to clashes in the streets. Basically, the economy remained in trouble.

By 2011, the Troika wanted more budget cuts but Greece needed more financial support. They received 109billion Euros through the European Financial Stability Facility, but it did little to help the economy. At this point, the country is merely fighting off the wolves.

And so it has been over the last 6 years. Greece negotiates bailout funding but the economy fails to find any traction. Some argue that it is the mindset of the Greek population that needs to change (early retirements and being supported by government pensions, tax dodging, government spending). But economic default is not new, and it will be something the world will continue to see in the future as it is how our economies are run.

Next Deadline looming

On June 5, the Greek government is scheduled to repay 300 million Euros to the IMF. This is the first of 4 repayments that total $1.76 billion. Economists expect that Greece has the ability to pay this first installment, but they might struggle with the remaining repayments.

The global stock markets are certainly not fearing default. Two years ago this situation resulted in the markets capitulating and retracing, causing volatility to increase sharply as fear of a defaulting Greece could lead to an exit from the EU.

IMF president Christine Lagarde was quoted as saying on Thursday 28th May that a Greek Exit from the EU was a “potential”. Doomsayers predict that a Grexit would be the beginning of the end for the EU, but leading economists are not so sure.

An exit of Greece from the EU would have minimal impact on most of the EU. It is the Banking system that would feel the brunt with much of the Greek debt owned by Central Banks and the IMF. Indirectly, the impact would be felt by the larger banking institutions in Germany and France.

Can Europe afford Greece defaulting on their loans? There is a real case for the default having an economic impact on Europe. Less money in the system, less ability to lend to more stable countries, and subsequently, a long struggle to recover.

But we have seen America thrive post-GFC, and Japan has continued to function as one of the largest economies in the world despite having one of the largest Debt to GDP out of all developed nations. More recently, we have also seen countries such as Ireland and Iceland, two of the most recent debt defaulting nations, recover and prosper.

News headlines might scream doom and gloom for world economics. But in the end, major changes will need to occur for Greece to start on the road to recovery. Either as the mindset of its people, or as a nation that plays the bankruptcy card and starts all over again.

 

This interest piece was written by Matthew Brown – US Equities and Options analyst @ Halifax Investment Services. If you have an opinion on the Greek Debt and what impact it will have on the European or Global economies, post a comment and share.

Since 1998, Matthew has been involved in the Financial Services industry providing stock, option and CFD advisory services, trading advice, funds management and education services. Matt is an Authorised Representative of Halifax Investment Services, providing analysis and recommendations for trading Covered Calls in the US markets and using Exchange Traded Funds (ETFs) ...
Follow Matthew Brown on Google+

Leave a Reply

Your email address will not be published. Required fields are marked *

*

Get Access To Your Income On Demand Opportunities

Sign up to receive the latest income generating how-to's, and ASX and US market insights!

Where should we mail you our latest income generating how-to's, and ASX and US market insights!?