As the G7 summit broke up on Saturday (sans communique), most of the media releases concerned themselves with the Greek and European debt drama. All of the releases through the media place great belief in the Greek government’s ability to cut their deficit to 3% during a three-year period. The repitition of this belief in a fantasy challenges the credibility of those who make financial policy in the developed world.
We know that they are trying to stem the possibility of contagion throughout the PIIGS, but the more they pretend the greatest the risk becomes. A constant criticism we have of financial leaders is their continued belief in flawed models rather then real world activity. The markets keep telling the policy makers they have no respect for their statements and want to see action. The Greek situation is creating a serious negative feedback loop for the Greek budgetary process as higher interest rates on long term debt is draining more money out of the budget.
This spring brings the rollover of a large chunk of Greek debt. The market will exact a huge price to prevent a default, but this price will be a huge drain on the Greek treasury. The most recent numbers we have seen is that the need will be to borrow 53 billion euros. Even with most of the loan done in shorter durations, the interst on the debt will be an overall 12.95 billion euros, or 5.3% of total output. As the markets push Greek rates higher, the cost will escalate as the economy shrinks because of the severe budget constraints. When we get comments from Geithner and others that they have full faith in the Greeks to meet their promises, we know they have brain freeze.
The further problem is that many large European banks are the owners of a large amount of Greek public and private debt. We include a chart from the BIS depicting which countries’ banks have the largest exposure. The situation is not very promising regardless of what the global financial leaders continue to say in order to buy some time. The equity an commodity markets had a late rally on Friday hoping that some real support program would be put in place. We await, but from our standpoint hope is not a policy.