Thursday, April 29, 2010

Thinking About PIIGS

The debt crisis unfolding in Greece, and another probably coming up in Portugal and maybe even Spain, is interesting for me. It is an opportunity to deepen my understanding of what it means to be involved in a debt default which could be our experience someday in the United States. I have read the size of these economies, as a percent of the European Union (EU) GDP, is reported to be about 2% for Greece, Portugal is less at 1.5% and Spain is a meaningful 9%. So why all the fuss and worry over the two small economies?


If the world were not populated with debt soaked economies, there probably would be much less to wonder about. But Greece is one of the first examples, since the financial crisis reached epic proportions around the world in late 2008 and early 2009, of what a debt crisis creates within the borders of the affected economy. Iceland is another, even smaller example. However, the current example is unique because Greece and all of the countries that make up the PIIGS are members of the European Union. It's a single currency union as well as a relatively new currency experiment. There is no precedent for what to expect, only theories. As a result of this union, what goes on in Greece and the PIIGS, is going to directly impact the exchange rate of the euro, and be a concern to the all 16 of the union members. The US$ is certainly not as new as the Euro which was established in 1999, but is there much else different when contrasting the United States and its 51 member states compared to the European Union? Will California, the sixth largest economy in the world, need to be rescued before Spain?

The common practice of western governments, for dealing with their immediate debt fueled crisis, has been to create more debt and worry about it later. 'Later' is probably going to catch up with us all who practice this foolery. Greece has relied on tomorrow's mail bringing a new source of economic growth or development of existing sources since they joined the EU, with no satisfaction.

My interest now is what the impending default looks like in Greece and what will be the financial ripple effect. To my surprise, the amount of outstanding Greek debt seems to be unknown! Michael Shedlock has more on this in a post he titled How Much is Needed to Bail Out Greece? As a result, the ripple effect is going to be of great interest to many observers as it evolves over the coming months when banks and other Greece bond holders deal with their maturities. Many banks in the EU are already weakened from their unhappy experience with losses from derivatives on mortgage securities. Incurring more loss from bond defaults will make matters worse certainly and depending on the size of the loss, might be the final blow for one or more banks.

Martin Feldstein has an article on Project Syndicate titled Why Greece Will Default that describes some of the possible characteristics of a debt default as well as some unique factors that combined to work against Greece, leaving them without much of a warning mechanism. He concludes that thought saying, "But, whatever form the default takes, the current owners of Greek debt will get less than the full amount that they are now owed." I notice in his writing that "default" has a different definition in this context than what I am familiar with from my household economy experience, ie if I were in default, you would suffer a total loss.

Also, of interest as an observer, is that Greece is being forced to face up to the reality it has created and a lot of Greeks are revolting. There are public riots and workers striking, as if that will improve the conditions they have to adjust to. In a few years, maybe more, a movie requiring economic change is coming to a theater near you and me. It's probably going to get more interesting here too. Scanner