At this point, it is inevitable that Greece is going to default and we may even have an exact date: March 20. About 14.5 billion Euros worth of bonds are becoming due on that date, the equivalent of around 19 billion dollars, around 6 percent of their total GDP. However, they’ve been bailed out before; why not do it again?
There are numerous problems with that. First of all, the European countries and Germany especially, are sick and tired of bailing them out. They’ve received two bailouts over the past 18 months and it’s like throwing money down a black hole. It’s become evident that they will cut nothing from their massive budget, or at least do nothing more than symbolic cuts. The German public, i believe, are the most hostile to this, but many countries are following in their footsteps.
The second are the investors themselves. According to the deal they’re trying to hammer out, investors would lose about 70 percent of the money they hold in bonds. To put it in a different way, imagine being told that you would lose 7,000 out of the 10,000 dollars you invested into a country or company. Many aren’t willing to do it, particularly since many of them possess Credit Default Swaps. It’s essentially an insurance policy stating that if what you invest in defaults, you will be paid in full. For them, a better alternative would be to let Greece default and collect on the insurance.
The third is that Europe is running out of money, period. Greece is the worst off, but virtually everybody in Europe are having problems that make the economic situation in the United States seem rosy by comparison. Last week, S&P downgraded 9 European countries, some by two notches; France and Austria lost their AAA credit rating. Fitch is about to launch a wave of downgrades as well, which we will see by the end of the month.
This is a distinctly ominous sign. As of now, Spain’s rating is A and Italy’s credit rating is BBB+; that’s only slightly above junk bonds. Portugal has already been downgraded to junk last week. In 2011, downgrades happened every two to three weeks, but it was one or two countries at a time. For the beginning of 2012, 9 were downgraded and in the next planned downgrade taking place within 11 days, it appears as if 6 European countries will be downgraded. If we’re advancing from downgrading one or two at a time to several, that does not bode well for the world financial system.
If it was Greece alone, the EU and the Eurozone would survive. Granted, they would still be hurt by a default in any case, but they would survive. However, it’s not just them: many Eurozone countries are falling apart. Apart from the PIIGS countries, Belgium is joining that list and it looks like France is not immune, either. The question is: what are we going to do if Italy needs a bailout? By that point, I expect Greece to have defaulted, but Italy is the 8th largest economy in the world. Bailing them out is going to be, putting it mildly, very difficult to accomplish.
Let’s also consider that one year ago, both Italy and to a lesser extent Spain looked like stable economies. Throughout 2012, I fully expect others to join this list, helping to bring down the whole house of cards. They are our biggest trading partner and their difficulties are going to end up affecting us. How much… we’ll find out.
What’s happening in Europe should serve as a warning to us about where we are heading. Most troubled countries are finding it nearly impossible to cut spending in any meaningful way. We’re not having any better luck, and this is precisely the kind of model that President Obama is attempting to take us towards. We have to change course and quickly; this level of spending cannot be sustained, as we’re rapidly finding out. We’re just a ways behind them and catching up quite quickly.
The only good thing about this is that it makes it that much harder for Obama to win another term.