We all know what is going on in Greece. Here is Dylan's eloquent summary:
Greece misrepresented the true state of its finances, it has enormous off-balance sheet liabilities, it is expected to run a double-digit budget deficit to GDP this year, it has a heavy bond issuance schedule this year – it was bound to have a crisis at some point wasn’t it? But what’s the difference between Greece and the rest of the OECD? Only that it is small enough to be bailed out ….
Greece, as we have long been claiming, is just the beginning.
Back in January, when Greece?s problems first surfaced, I thought it would be the first in a series of fiscally driven market seizures in the following months which would potentially offer up some decent opportunities to buy stuff cheap ? I guess I got that one wrong ... but I still think Greece is the beginning of a wave of government funding crises, not the end.
For starters, we’re not out of the woods yet. The chart below shows my back-of-the-envelope calculations for the colossal amounts of debt governments need to issue this year relative to that already outstanding. I?m not a bond strategist and I?ve not done anything sophisticated or clever, but by taking Bloomberg?s data for existing debt maturity for each government (red) and using the OECD?s projected 2010 deficits as a proxy for net new issuance (grey) my numbers shouldn?t be too far out. But if my numbers are even roughly right and issuance is the problem, Greece should have had almost the least to worry about!
But it’s not just about getting this year out of the way. If it can happen in Greece, it can happen everywhere else too, because Greece just isn’t that different. OK, so it misrepresented the size of its liabilities ? but so too do most other governments; its real fiscal problems are hidden off-balance sheet in the enormous welfare obligations it can?'t afford to pay ? and so are most other governments? (first chart inside); its debt maturity isn?t notably different from the rest of the OECD?s (at about eight years it?s actually longer than those of the US and of Japan ? second chart inside); and its projected budget deficit is lower than those projected in the UK and the US (third chart inside).
In fact, the charts above show that there are no clear thresholds which say when a country will undergo a fiscal crisis ?- the UK had to call in the IMF in 1976 with a debt to GDP ratio of around 45%. Japan has a debt to GDP ratio in excess of 200% and hasn?t had any funding problems (yet). What counts is confidence, and what hurts is when weakening confidence pushes up the market risk premia on a country?s debt, pushing bond yields and therefore interest costs to such a level that government finances becomes unsustainable.
To be sure confidence is certainly buoyed by the knowledge that the deranged madmen at the money printing asylum have full access to the seemingly infinite pulp resources of northern national park neighbors. That and ink. And Greece has neither. But at its core the problem is simple: if you can't outgrow your debt, you die. To wit:
The unavoidable arithmetic behind debt sustainability is that the interest a country pays on its debt must equal the nominal growth rate of that country. If it does, the incremental government revenue generated by the economic growth will pay for the coupons on the debt. If it doesn?t, a shortfall develops between incremental revenues and incremental coupon payments and in the absence of further austerity, more debt is required to finance the deficit.
And here is the Catch 22 of the EMU. When will the Euro bureaucrats finally realize the euro is doomed?
This might sound abstract, but it?s exactly what happened in Greece. When the first austerity plan was presented, Greece cut public sector wages by a painful 10% causing angry protest and social unrest, although it saved the government ?650m. But the same austerity plan assumed Greece?s interest cost would be 4.7% and by late February it was paying 6.25%. According to the WSJ, this has blown a ?700m hole in its budget, more than offsetting the savage public sector wage cuts already enacted. Public sector pay would have to have been cut by an additional 10% to achieve the same budget repair that had originally been intended because interest costs were spiralling faster than expenditure could be brought under control. Even after the bailout agreed this weekend (which at ?30bn falls significantly short of the ?75bn The Economist believes is required) the cost of borrowing from Mr Market as I write still stands at (a bestial ...?) 6.66%, and that is even after the EU rescue plan was announced.
If Dylan is right,look for the upcoming Sotheby's auctions of various Cyclades islands to move to the Chunnel quite soon.
So I?d be surprised if this is the last we?ve heard of the Greek crisis. But without wishing to belittle their plight, the more terrifying spectre is of similar dynamics unfolding in larger economies. For the most chilling similarity between the Greeks and everyone else isn?t in the charts above showing that their various debt metrics are in the same ballpark, it’s in the realisation that we too are subject to the same iron-clad laws of budget sustainability and that we too are as helplessly vulnerable to any reassessment of sovereign risk by the famously fickle Mr Market. The Greek tragedy of being unable to pay for the debt built up during the years of unprecedented low yields reads across to the rest of our governments all too well. The fact is most of us are living on the same knife edge.
But Greece is a small enough economy to be bailed out by Europe. If we add in Portugal, Ireland, Ireland and Spain (the rest of the so-called PIIGS group), the risk could be systemic (see table overleaf). And in recent months I?ve written about the time bomb that is Japan?s government bond market, where I think the end game is in sight. Who, when the time comes, will bail them out? US health costs are escalating explosively and represent arguably the least tractable of all sovereign issues today. They too are subject to the arithmetic of budget sustainability, from which there is no hiding place. The difference between the rest of the OECD and Greece is merely that Greece could be bailed out.
For our previous perspective on the $1.5 trillion in total exposure by European Banks to "Club Med", read here.