Greek Woes and Potential Default

The Greek Debt problem speaks volumes about whether the European Union will ever politically unify. Public opinion in EU's richer countries is quickly turning against their elected officials who have been forced to bail out struggling EU members again and again.

Greece currently owes a whopping $420 billion USD debt (around 120% of Annual GDP of $329.92 Billion). To complicate matters, Greek debt has been downgraded by Standard and Poor's to triple C minus, the lowest possible rating for Sovereign Debt. Today Germany and France have reluctantly agreed to a second bail out similar to last year's bail out of €110 billion. Last year's bailout only partially covered Greece's debt on maturities through 2013. "The EU and the IMF in February estimated that Greece would need €44 billion in long-term financing from the start of 2012 through the first half of 2013 (http://www.azadnegar.com/article/greek-debt-plan-gains-support)."

While the Euro removed trade barriers between Euro zone countries, it also removed Greece's ability to control their own monetary policies. Greece, and other Euro members in trouble (notably Ireland, Portugal, and Spain) are forced to beg for help from the stronger countries such as Germany (who keep the Euro valued high versus other global currencies at it's current price ~1.43 to $1USD).

If Greek currency was still denominated in the drachma, economic trouble would cause the currency to devalue relative to other currencies, encouraging trading partners to buy their exports, and improving their ability to pay creditors. As the situation currently stands, Greece's only salvation lies in a technological breakthrough that results in a massive influx of business or a substantial increase in the productivity per capita of Greek Workers...both very unlikely.

So what does this mean? Austerity measures, Bondholder Haircuts, and Bond Swaps (extensions of the maturity of current government debt)

Austerity measures proposed: information from BBC (http://www.bbc.co.uk/news/10099143)

• Pay freeze for all public sector workers, pay cuts for some workers. (note that these cuts increase yearly pay increases ~30% annually since 2006)
• Private sector firms ability to lay off employees proposed to be doubled from 2% to 4% monthly
• Pension Reform: Retirement age proposed to be linked to life expectancy. Reforms proposed to prevent early retirement. Pensions will be reduced to reflect worker's average pay rather than a percentage of final salary.
  
• Tax Reform: Value-added tax increase from 21% to 23%, 10% increase on alcohol, fuel and cigarette tax, crack-down on tax evasion.
  
• Long-run Privatization: efforts to encourage growth in the private sector in the long-run.

The Prime Minister of Greece, George Papandreou, strongly believes that Europe will only support Greece if the austerity measures are adopted. Violent protests of these proposals cast doubt on their successful implementation.

Bondholder Haircuts: Any proposals to solve Greece's debt problem and avoid default will likely be accompanied by pressures for private sector investors to share the burden through writing off a portion of the Greek Debt. The degree of financial loss for investors remains to be seen. Fears of default and write downs are signaling a 'flight to safety' in the bond market.

Bond Swaps: Bond Swaps are essentially extending the maturities of debt by several years. Germany, as one of the strongest economies in the Euro zone, was calling for Bond Swaps that would extend the maturity of Greek debt by 7 years in exchange for another bailout. Yesterday, Germany backed down from this stance, as rating agencies have implied that a bond swap would be interpreted as Greece Defaulting on its obligations. The European Central Bank is instead encouraging voluntary debt rollovers. (http://www.reuters.com/article/2011/06/16/us-greece-germany-bondholders-idUSTRE75F1AK20110616)

It will be interesting to see how events will unfold in the coming days and weeks.