The Eurozone Crash

In an absolutely predictable fashion the leaders of Eurozone’s solvent nations have cobbled together a deal to save the beleaguered Greek economy from defaulting on its debts. Predicable because firstly if Greece had been allowed to default and quietly leave the single currency scheme as it should have been, then Ireland, Portugal and probably Italy, Spain and Belgium would have followed in close order.

So again we saw TV pictures of the smiling front men and woman led by Angela Merkel and Nicolas Sarkozy arriving at an anonymous and stereotyped office in Brussels, grinning like idiots as they promised to “work together to find a solution to Greece’s problem. The jargon of international finance debt-to-GDP ratios, bond yields, haircuts, and deficit levels made even the rush hour traffic fumes seem only a minor pollutant, but what does it all mean?

Imagine someone you know who is not really poor but not exactly rich either. Their annual income is £20,000, below the national average for individuals but better than being on the dole or burger flipping and shelf stacking for minimum wage. Now let’s assume your pretend neighbour has run up personal debts of £30,000 over the years, and told a few porkies along the way to get their credit card limit raised and obtain a bank loan for a car and overdraft facilities to finance an extravagant lifestyle.

Finally however the bank and the credit card company have spotted that the neighbour is no longer borrowing to pay for cars, 60” Plasma TVs, foreign travel and such but is borrowing to finance living expenses and pay the interest on existing debts. Naturally the financiers have turned awkward, refusing any more credit and demanding that the loans be paid off at an interest rate of 40%-plus.

The next step is they will send in Lefty and the boys.

Your neighbour is not Joe the regular bloke but Greece, a small country that is better off than Bulgaria but not as well off as Germany. Greece’s debt is running at 150% of national income and where there is not the remotest hope of turning the financial position around. Here a little insight into the workings of bond markets is needed.

Traditionally Treasury Bonds were issues in E1000 (face value) units, redeemable at three or ten years and for treasuries usually at an interest rate of between 3% and 4% on face value. The Bonds are sold at a premium of discount (a price above or below face value) based on the economic stability of the nation and the prospects of inflation eroding the value. Calculate the interest due on the face value as a percentage of the actual price paid to determine the yield.

Greece’s bonds are currently being sold at heavily discounted prices with twelve month and six month redemption dates at an interest rate of around 15% on face value. The face value versus actual price arithmetic gives us yields in the region of 40%. Unreasonable? Not really when the likelihood of default and the predicted levels of inflation are taken into account.

In similar circumstances, an individual would respond in two ways. They would try to boost their income, perhaps by doing a bit of moonlighting as a cab driver, prostitute or waiting on tables and maybe tighten their belts and cut down on living expenses.

Or they would apply for a bankruptcy order, in effect defaulting on their debt obligations. But interest rates of 40% would mean the £30,000 debt gets bigger even though the new part-time job is bringing in a bit of extra cash and austerity measures have been implemented. The credit card bill gets bigger and bigger, despite all the austerity.

Like an individual struggling with debt Greece has passed the hat round to friends and family in the hope that they will help. In particular, it wants the German relatives to do what they have done during every other European crisis of the past half century – write a big cheque to make the problem go away.

Uncle Fritz and Auntie Gertrude have grown tired of ponying up for the spendthrift members of the family. While political leaders may think saving the Euro is the priority German (and French, Dutch, Austrian and Finnish) 2 taxpayers think that instead of chucking good money after bad to subsidise the idle slackers of southern Europe it is time to keep tax money at home where it can benefit the hard working and prudent people on whose labours economic success was built.

It is time, they think, for the Greeks to get off their arses and get some work done while abandoning the unrealistic sense of entitlement that says sitting under an olive tree playing Pan Pipes and watching sheep eat grass all day is worth as much as building Mercs, Beemers, VWs, aircraft, diesel engines, radar systems and electrical goods.

An individual would at this point realize the game was up. If the rich relatives turned down the appeal for an emergency loan there really aren’t any options left except to go bankrupt.

The analogy breaks down here. If an individual goes bust, there is plenty of pain and lots of misery but it is confined to a relatively small number of people. If a country goes bust, it affects all the banks and pension funds that have advanced shedloads of money down the years. German and Dutch banks.

French and Austrian pension funds. And British and American financial institutions too. That’s why Greece will have the interest rate cut on the money it borrowed from other members of the European family. And why another massive loan will be approved.

We must however be near if not already at the point where voters rebel.

Ian Thrope