Caught In A Greek Debt Trap

All too often in the world of money we think of things in the abstract. Money is after all an abstract concept. But at its core, economics is about human beings going about their daily business. We make choices. And these choices filter through into the financial world.

At least, in a free market that’s how things are meant to work. In today’s increasingly interventionist world, the process also works in reverse. That is, what happens in the abstract financial world – such as the Greek debt crisis, has a major impact on human decisions.

And we mean major. Take this report from the BBC

Greece’s financial crisis has made some families so desperate they are giving up the most precious thing of all – their children.

One morning a few weeks before Christmas a kindergarten teacher in Athens found a note about one of her four-year-old pupils.

“I will not be coming to pick up Anna today because I cannot afford to look after her,” it read. “Please take good care of her. Sorry. Her mother.”

Is this what trickle-down economics has become? Decisions made to protect the banks and the precious euro project has bled Greece dry. The country is in a depression.

As the following graphic shows, Greece’s economy shrunk by around 5.5 per cent in 2011 and could contract by a further 6.5 per cent in 2012. With no debt relief in sight, Greece’s debt-to-GDP ratio continues to climb as GDP shrinks.

Greece's gross domestic product and umemployment

The country is in an economic death spiral. The Washington Post reports…

“Conditions have deteriorated so dramatically that doctors in this country now believe that the Greek crisis is no longer just a financial crisis but a humanitarian crisis,” said Dimitris Varnavas, the president of the Federation of Greek Hospital Doctors’ Unions.

Towards the end of 2011, Greece moved to the side of the financial stage, giving room for Italy to play a starring role. But that has not stopped the economic situation deteriorating daily.

The markets stopped worrying about Greece towards the end of last year when one of the many emergency summits stumbled upon a ‘solution’. The bureaucrats decided that holders of Greek bonds would take a 50 per cent haircut, with the aim of reducing Greece’s debt burden to a ‘manageable’ 120 per cent of GDP within a decade.

Although it was a farce, the markets liked the short-term respite it offered. Now, events haven’t played out the way the central planners, err…planned.

Over the past few months, the banks that originally held the Greek debt have sold much of it to specialised hedge funds. The whole agreement about taking a ‘voluntary’ 50 per cent write down on the value of the debt is now in question. The hedge funds don’t want a bar of it.

There is a large chunk of Greek debt – around €14.5 billion – maturing in March. Greece needs the next tranche of the IMF bailout funds to make the payment. Because the hedge funds now own a large amount of this maturing debt, they have no incentive to agree to a voluntary restructuring.

It’s a high stakes game. Without a deal on voluntary restructuring, the IMF says it won’t pay the next bailout instalment. But if it doesn’t provide Greece with more funds, it risks bringing on a disorderly default. This is the precise outcome everyone has tried to avoid from the start.

An outright default or a forced (non-voluntary) restructuring would trigger all the insurance policies (credit default swaps) taken out to protect against a Greek default. This could knock down the house of cards that is the European and international financial system.

Those writing the insurance have most likely hedged their exposure to someone else – and so on and so on – until no one knows where the risk really resides. And no one wants to find out.

So we’re back to where we started with bankers and politicians desperate to avoid a Greek default, but with no credible plan to achieve such an outcome.

Despite the billions of euros in aid (which has only gone back to those holding maturing bonds) Greece is even deeper in debt and has a much smaller economy than when this whole mess started. Its debt-to-GDP ratio will be much higher than anyone expected. That means ever greater haircuts, or all-out default, is the only way out of the debt trap.

But right now, a debt trap is what it is. We can talk about numbers and hedge funds and default and what it all might come to ad nauseam. But a debt trap is a social disaster. Among many other individual tragedies, it results in parents giving up their children. This already happens in many developed societies, but in Greece, where the family unit is sacred, it’s a very big deal.

Despite the market’s optimistic tone to start the New Year, expect Greece and Europe to be back in the headlines very soon. And in a very big way.

Tomorrow, we’ll take a look at the European Central Bank’s role in all this… and why it’s important for Australia.

Greg Canavan
for Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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2 Comments on "Caught In A Greek Debt Trap"

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If these doctors are so concerned maybe they should start paying their taxes? Greece, the only Western country where it was the general population that sunk the banks…


The actions of those in power who manipulate and control the status quo to their own benefit, their actions have taken money from those who had little enough to begin with. In a myriad of small ways they have hastened the deaths of many, they do not know them, they do not see them bleed. But they have snatched bread from their mouths and tore clothes from their backs.

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