29th Jun 2011 - A summary of the Greek Financial Crisis
A summary of the Greek Financial Crisis and how it could affect you.
To sum up; Greece has been spending beyond its means for 15 years. It now owes 150% of its GDP, which in real terms means it owes one and a half times its country total output per annum.
This debt to output ratio is rising all of the time. The reality is that it was fighting to pay down its deficit prior to entering into a deep and prolonged recession which made its position further untenable. It has borrowed so much money that it can only afford to pay off the interest on the sums borrowed but can only afford to pay off that part with borrowed money, so its caught in a trap. Having passed the much dreaded additional austerity measures the harder part will be the implementation, which however you look at it will damage the economy further making it even more difficult to repay the loans.
As Greece cannot and will never be able to pay down the capital sum it is inevitable that it will default at some point in the future.This is the point. The question is not whether Greece defaults but when it will default. The markets have quite rightly responded positively. There are two trains of thought:One, we let them default now. This is what the markets want to avoid. If Greece defaulted now, it would mean the European Central Bank (ECB) and many international Banks (including UK banks) losing significant sums of money at a time when many of them are still rebuilding their balance sheets after the last crash and also fighting to increase internal liquidity to meet new capital adequacy requirements imposed on them by the regulatory authorities. The markets would push up the interest rates on other debt such as Ireland, Portugal, Italy and even the UK, though this is less likely.
This would likely mean a Credit Crunch II as the banks would not be able to lend and the negligible increases in domestic lending would be wiped out; the economy could well slide back into a shallow recession and all that comes with that. We have all been there; we know how that felt.Secondly, we let them default further down the line. This is what the markets pretty much expect. This whole process has been about buying time and pushing the eventual fall-out to a time when the economy is more affluent. If we allow them to default further down the line when the global economy can absorb such an impact contagion is a lot less likely. The idea is that further down the line the banks will be in a better position to allow a structured default. I.e. they will be able to part write-off some of the loans to allow Greece to reduce the capital sum. This could be a loan for 50 years or so. At the moment they are not able to do this as the banks can’t afford to. If Greece defaults after four years or so we the UK shouldn't feel the pain. The markets will jitter but will recover within months.
This is a world of many thoughts; what’s yours.