Disclaimer. After nearly 40 years managing money for some of the largest life offices and investment managers in the world, I think I have something to offer. These days I'm retired, and I can't by law give you advice. While I do make mistakes, I try hard to do my analysis thoroughly, and to make sure my data are correct (old habits die hard!) Also, don't ask me why I called it "Volewica". It's too late, now.

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Thursday, June 16, 2011

The Greek Debt Crisis (again)

Once again, markets are being roiled by concerns that Greece will default on its debts.  For some time now it's been obvious that a restructuring of Greek debt is inevitable, but bureaucrats and politicians have continued to pretend that austerity will be enough to guarantee payment.

The Greek government’s debt to GDP ratio exceeds 100%.  This means that the interest paid on this debt will be a significant percentage of GDP.  If interest rates are low, say 1 or 2%, as they are in Japan, the interest cost of the debt will also be low.  But if doubts arise about the ability or willingness of the government to repay the debt, then interest rates start rising, and the interest burden starts to rise as markets increase the risk premium applied to that country’s debt, thus increasing the risk that the debts won’t be paid.  This doom loop has hit Greece.  10-year bond yields are now above 17%. 

The burden on the Greek population is insupportable.  It is likely that the government will fall today or in the next few days and Greece will default.

Does this crisis mean you should switch into defensive investments such as cash?  No (though it's close) for 6 reasons:

  1. Chinese growth will continue. China is the world’s second largest economy (and is the world’s largest consumer of raw materials).   Chinese growth is now driven by internal forces rather than exports.
  2. Though US growth is slowing this has much to do with natural disasters – the tsunami in Japan stopped car part production which affected US car production and sales; and floods in the mid-west also impacted output and sales.  Outside the PIGS (Portugal, Ireland, Greece, Spain) growth in Europe is strong.
  3. Share markets are a lot cheaper than they were--though they're still not screaming buys.
  4. The markets have seen this crisis developing over the last year, and most of the bad news is now “in the price.”  Nobody now believes Greece will avoid default except bureaucrats and politicians.
  5. Policy makers are extremely aware of the dangers and will move aggressively to ease liquidity on any sign that the crisis is spreading.  If necessary, central banks can buy bank bonds or lend banks unlimited cash on the security of government paper or even lend them money directly.
  6. Unlike the situation at the beginning of the GFC, when economies were ripe for a cyclical downturn, now we are still in the middle of the upswing from the trough of the recession.

But it's hard to see share markets booming on this, isn't it? 

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