As Greece heads for treacherous waters in this debt storm, I can only wonder whether Greece will soon default. Amidst the political turmoil among Greek parties and disagreements between Greece and other Eurozone members, this beckons the following question: Can Greece avoid disorderly default?
Despite recently passed austerity measures including a cut in government jobs, a decrease in the minimum wage, as well as reduced pension benefits, it doesn’t address Greece’s long-term problems. A 50% haircut on its current debt would only lower Greece’s debt-to-GDP ratio to 120% by 2020. And the real economy would suffer immensely as already seen by rising unemployment and falling incomes.
Let’s not forget that Greece has defaulted many times before, raising doubts as to whether it can stay in the Eurozone. There has unfortunately been a pattern of Greece accepting loans and failing to pay interest payments on debt in a timely manner. To make matters worse, since Greece’s independence in 1822, it has been in a state of default for over 50% of the time.
Looking at the PIIGS as a whole, Spain has also been a troublemaker, having been in default almost 25% of time since 1800. And Portugal is not too far behind. While one could argue that these countries recovered at some point after default, the current situation is quite different. With a European Union where there is a common currency, a unified monetary system, and greater cross border lending, a disorderly default could trigger a much more volatile reaction on a global scale.
Looking at other defaults, the most notable recent default was Argentina in 2002. Nevertheless, the restructured debt in that deal had a smaller haircut and Argentina was not part of any sort of economic union in which other countries had to intervene significantly although there was IMF aid. Not to mention, the debt-to-GDP was below 100% while the total amount of bonds was much lower than Greece. In other words, a Greek default would be more contagious and injurious to investors with greater long-term ramifications.
Although I’d like to believe that Greece can commit to paying off its debt and restoring confidence to global financial markets, I’m weary to say the least. Considering that agreements need to be made with bondholders, the IMF, the ECB, and other groups while trying to please the populace, staving off default will be a tall order. It also doesn’t bode well when the Greek 1-year bond is at 629%!
If you have some extra time and want to study defaults in greater detail, please look at this excerpt from Sovereign Defaults and Debt Restructurings.
As we’ve seen lately, there hasn’t been a consistent market reaction to developments in Greece. I think it’s safe to say that the U.S. won’t be as affected by a potential Greek default as Europe would be, but we can’t take any chances as the weapons of mass distraction (Credit Default Swaps) have risen to some $600 trillion dollars (globally).
Therefore, having a solid mix of bond and equity ETFs with a domestic tilt is the way to go but only if, additionally, you have an exit strategy in place as well.