Greece: Between Dire and Disastrous

John Mauldin

The news is somewhat “All Greece, All the Time,” but most of the pieces miss the more critical elements, and today we’ll look at what I think those are, as well as at the important point that Greece is a precursor of a new era of sovereign risk. Plus, we glance at a few rather silly recent comments from economists. It will make for a very interesting discussion.

A Path-Dependent World

Path-dependence explains how the set of decisions one faces for any given circumstance is limited by the decisions one has made in the past, even though past circumstances may no longer be relevant. In essence, history matters.

With regard to the future, the choices we make determine the paths we’ll take. As I’ve been writing for a long time, we’ve made a series of bad choices, often the easy choices, all over the developed world. We’re now entering an era in which our choices are being limited by the nature of the markets. Not only are we in a path-dependent world, but the number of paths from which we may choose are becoming fewer with each passing year.

Our economic future is more and more a product of the political choices we make, and those are increasingly difficult. We have no good choices. We’re left with choosing the best of bad options. Some countries, like Greece, are now down to choices that are either dire or disastrous. There’s no “easy” button.

Let’s look at how Greece came to its current rather dismal predicament. And we’ll look at why it may be even worse than many pundits think.

First, we need to go back to the creation of the euro. Most of the Mediterranean countries that are now in trouble were allowed into the union with an exchange rate that overvalued their currencies relative to the northern countries, but especially to Germany. That meant that Greek consumers could buy products and services that previously may have been out of their reach. Plus, with government debt at low rates, the Greek government could borrow more to finance deficit spending, without the threat of higher interest rates. And Greece began to increase its debt with abandon.

Additionally, as it now turns out, Greece basically lied about its finances in order to gain admission to the union. It never complied with the fiscal discipline that was required for entrance.

With the high exchange rate, however, came the consequence of higher labor costs relative to, above all, Germany. While reviewing some economic facts about Greece, I came across the factoid that Greek workers had the second highest level of actual hours worked. But even with that, Greece was running a trade deficit that is currently 12.7% of its GDP.

And with the onset of the current recession, their fiscal deficit went from bad to worse. Their total debt is now €254 billion, and they need to finance another €64 billion this year, €30 billion of it in the next few months.

Bottom line, without some help or a bailout, they simply won’t be able to borrow that money. And since a lot of that money is for “rollover” debt, it means the potential for default if they cannot borrow it.

European leaders said today that Greece won’t be allowed to fail, hinting of a bailout. But there are a lot of “buts” and conditions.

Click to read Page 2 at Minyanville …