Greece: Our Debt, Your Problem

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Greece: Our Debt, Your Problem

By Paul Kedrosky February 15, 2010
Good insider-y and cynical reading on Greeces debt non-problem problem that has been making the
rounds, allegedly written by an anonymous in-country banker:
GGBs: Our debt, your problem.
If Greece defaults, it will be the biggest sovereign default in history. If Greece is bailed out, it
will be the biggest sovereign bailout in history. Thats what you get when theres EUR 250
billion at stake. The Russian and Argentinean defaults, both south of EUR 60 billion, were not
even a quarter as big. Thing is, as a Greek Im as worried about the whole thing as a resident of
the fictitious South Sea would have been when the South Sea bubble went bust. Heres why:
Debt is not dealt with very well by economic theory. Debts net out. For every lender there is
necessarily a borrower.
Total wealth is the dollar amount it takes to control every home, every corporation every
consumer durable and every privately owned resource. No mention of debt here (though if you
want to get difficult, you will point out that to control a corporate you need to own both its
stock and its debt, but bear with me) Thing is, if you add a bit of debt, you untie a lot of agents
hands. If a 35 year old heart surgeon has access to the mortgage market he can move into a
beautiful house before he collects his first ever paycheck, and hes definitely good for the
money.
That pushes up home prices. So a bit of debt definitely pushes up total wealth. On the other
hand, recent experience indicates that a whole lot of debt leads to breakdowns. If weve all

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Greece: Our Debt, Your Problem

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borrowed money to buy assets and for some reason they take a break from going up, marginal
borrowers who count on selling appreciating assets to service interest on their debt will miss
their payments. Their liquidator will sell their assets. This will drive down asset prices, which in
turn will trigger margin calls to more people and the vicious cycle can start that Irving Fischer
dubbed debt deflation. 2008 looked a lot like that and most people believe it had a lot to do with
overindebtedness.
We also need to look at savings. If a country has a lot of savings, it can support a lot of debt.
Japan has massive government debt, but equally massive private savings. Some countries, like
China have massive savings and have to look abroad for investments. And some, like the US
are the other way round. When it comes to debt, Greece is in a uniquely privileged situation.
No, seriously! For starters, we Greeks are some of the worlds richest people.
On the official statistics alone, we are comfortably in the worlds top 40 for per capita GDP. But
thats peanuts. Lest we forget, thats our declared income. Dont quote me on this apocryphal
statistic, but Im reliably informed that exactly six Greeks declared more than a million EUR in
income last time anybody counted. And exactly 85 declared more than half a million. So were
probably a bit better than top 40.
Either that, or this trading floor alone has more rich people than Greece. Hell, our new recruits
for this season alone could probably do it. If you have any doubts about Greek wealth, check
out on Bloomberg the balance sheet of the National Bank of Greece, Eurobank, Alphabank and
Piraeus bank, the top four. The four of them alone command EUR 164 billion in deposits!
Slightly misleading, since they all have operations in the Balkans, but thats almost one GDP,
lying in deposits!!! More to the point, how many Greeks do you know who keep their money in
Greece? Thats merely our spending money, its a small fraction of our savings and assets.
Dont even mention that a square meter costs less in Belgravia than in Psychico, Philothei or
Kifissia.
Bottom line, as long as Switzerland and Citibank are going concerns (for that is where we keep
the bulk of our savings), were loaded. Second, Greece scores well across all measures of debt
but one:
We have extremely low household debt / GDP ratio.
We have extremely low corporate debt/ GDP ratio.
We have extremely low bank debt/ GDP ratio.
We have a manageable total debt / GDP ratio. Half that of the UK or the US!
We only score poorly on sovereign debt / GDP ratio.
Thats it!
Greece is a country with rich, underlevereaged savers, underleveraged corporates and a healthy
banking system whose government happens to have borrowed a hell of a lot of money. But the
world has grounds to be scared: with rates at 5% and government debt comfortably above 100%
of GDP, servicing that debt costs 6% of GDP at the moment. GDP growth, in the meantime has
not touched 6% nominal in a long, long time.
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So heres the deal: No matter what happens, the debt is now at a level where its growth has
reached escape velocity. Even if Greece were to run zero deficit, ultimately we are heading to
default. We can default now or we can default later. Is that a big deal? Frankly, no. 75% of the
debt, probably more, is held externally. If JGBs fail to pay coupon, thats a disaster for Japan,
since 95% are held domestically. If GGBs fail to pay coupon, its far less catastrophic. For the
debt-deflation spiral to start, you need the debt to be internal.
With an alleged 216 billion held by foreigners (plus the recent 8) the contagion risks mainly lie
outside the border! Even the banks who are in the news for holding all those ECB-funded
GGBs arent as long as US banks are long Treasuries, for example, though they would
probably have to be restructured. Basically, the economy is paying 5% or even 6% of GDP to
service a debt whose failure will hurt three or four times more abroad than it will in Greece. Do
I look worried?
Supposing we default, what will be left is a AAA credit here. Give it five years and a line will
form to our door to lend us more. It would not be fantastic for us to default, granted, because at
the moment we are in a virtual reality where a bunch of greedy foreigners lend us a fresh 5% of
GDP every year on top of what they were lending us the year before. If we default they wont
lend us again for a short while. During that period we will have to live within our means. That
will be a haircut. But it wont be a catastrophe for Greece. Germany took a bigger GDP hit than
that last year, for example, and so did the UK!
Indeed, Im willing to bet Greeks continue to have good access to the international financial
markets, and heres why: as Im writing this, Greek shipowners owe some EUR 100 billion to
the international banking system.
Even with the Baltic Dry somewhere in the dungeon, this debt is being honored and serviced.
Greek companies will be just fine, basically. Its the government that is the joke here, not the
country! Nevertheless, a sovereign default by Greece will set off a cascade. Italy has tons more
debt than Greece and a much bigger proportion of it is held in Italy.
That wont be a picnic. It gets worse than that, of course. People like to talk about PIGS, but the
real oink oinks of the past decade have resided in the protestant part of the world. The United
Kingdom and the US have total debt of more than 400% of GDP. You can never grow your way
out of 400%, its as simple as that. And this concludes my first point: be careful what you wish
for here, because Greece is a rich country that will mainly hurt others if it defaults. Directly
(through the default) and indirectly, via contagion.
A default will have both negatives for Greeks (less money to spend) and positives, which dont
concern anybody here, so I will discuss them separately at the end of this piece.
This brings me to my second big idea here. When the Paulson / Bernanke / Geithner triumvirate
decided to save the banks in September of 2008, who exactly was saved? Was it the American
economy, as we are led to believe? What was the alternative? The establishment would have us
believe that there was no alternative.
It was hold your nose and save Wall Street or a return to the dark ages. As Joseph Stiglitz,
Willem Buiter and Paul Krugman were at pains to point out back then, an alternative existed:

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we could have done a GM/Chrysler on the banks. Expropriate the equity holders, pay 15 cents
on the dollar to the bondholders and nationalize. Had we gone down that route, there would
have been different winners and losers. Small business would have been a massive winner.
Rather than create zombie banks that are too busy pretending Ford is a great company (Ford
owes banks 24 billion) and commercial real estate is about to turn a corner, they would carry on
extending credit to small business. Sticking money into the zombies has had 100% the opposite
effect
of what was advertised. It has caused extend and pretend to the borrowers who are too big to
fail and has throttled the little guy. Business was a loser.
The newspapers have us think that bankers were the winners. We did not do too poorly, but we
are not the big winners. The big winners here are the baby boomers. Thats because they have
their name against some 80% of the value in all pension funds and insurance policies.
And if the banks had gone down, thats who holds their debt and much of their equity. Bottom
line, had the banks gone down, no insurance product would be worth a penny more than the
paper its printed on. So basically, the 2008 bailout sacrificed business, i.e. our generation, but
saved our parents. The US bailout was intergenerational transfer, pure and simple. Now, our
parents did not have enough kids.
The past 10 years has been the story of their struggle to sell us their homes and their equities at
the price that will allow them to retire conveniently as they turn 65. Theyve thrown low
interest rates at us to induce us to borrow against the homes they are selling us, but that
backfired because low rates have pushed down their bond returns and their dividends. And their
stocks have not gone up in ten years. The final straw was going to be the decimation of their
insurance contracts and pension plans, but Paulson, Bernanke and Geithner jumped in and
saved them.
Talk about the bankers is fashionable, but in the bigger scheme of things it was a side-show. Its
pretty much the same with the Greek situation. Yes, we Greeks have been naughty. Yes, we are
overindebted. Yes, we live above our means. But, much like the evil bankers, this has nothing
whatsoever to do with Greece. That is my main thesis here. The Greek saga (for I refuse to see
it as a tragedy) is all about saving the French and German baby boomers retirement.
Sleepy fund managers and insurers in the north of Europe decided that they did not want
currency risk and they did not much fancy credit risk. Sovereign risk denominated in EUR was
just the ticket for them to deliver on their promises. So the decision was made to lend money to
the Greek government. Tons of money. Leaving out wars, more than any country has ever paid
back that escaped default. Greece had no need for this money and indeed put it to horrible use.
But Greece is not the protagonist here.
This is a domestic issue for France and Germany! The governments of France and Germany
have a choice here. They can side with the baby boomer generation, tax its progeny and funnel
the money to Greece. Or they can refuse and have the baby boomers reap what theyve sown.
But the bottom line here is that if the money had not come to Greece it would have gone to
Italy, Spain or Portugal. It wouldnt have gone to Bunds and OATs, because they did not yield
enough for these wide fund managers taste.

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The goings on in America, where nobody is thankful for having been saved and where the
economy is suffering the result of a misguided, short-term decision may push the French and
German government to say the Greeks dont deserve a bailout and allow their insurance
behemoths to take the hit. But I would not bet on it. My money is that the baby boomers prevail
again! Make sure youve covered GGB shorts by the end of the week!!! I, for one, hope were
allowed to default, and heres why: Once upon a time, Greece was a model small democracy.
An extremely frugal government ran tight budgets and provided an extremely basic safety net,
and truly threadbare services for a very low cost: Tax collected was minimal.
While tax rates may have been high, collection was virtually nil. A small oligarchy was the only
source of capital and had the acumen, education and experience to deploy it as the country
developed. Old families controlled the steel, cement, foodstuffs and construction companies that
rebuilt Greece after the war. As recently as 1980, debt/GDP was at 30% and it would have been
much lower were it not for the high costs of defense. When Greece joined the EU in 1980, all
that changed. It was party time. Money that was sent to build the Greek infrastructure was
funneled pretty much directly into the pockets of the oligarchy as well as the new Socialist
oligarchy that emerged.
This was not chump change. It was 6% of GDP for 30 years. With the exception of farmers,
who did extremely well off of the Common Agricultural Policy, the rest of the money went
pretty much straight to Swiss bank accounts. As an example, Greece has paid 250% over list for
F16s and Mirage fighters and has spent EUR 750 million for an airport that was built by the
same company that originally bid EUR 220 million for the project. No prizes for guessing what
happened there. Once the addiction to easy money set in, the government of Greece was
transformed from a lean provider of defense, basic health, basic education, a basic road network
and extremely basic pensions to an auctioneer of projects to the oligarchy.
The families who control business in Greece used a system of bribes the government was happy
to accept and set up a newspaper each to deliver threats its members would rather not. Sticks
and carrots, and lots of Euros. And once the system was established, there was no need to stick
to the money that was coming from the EU. ERM entry cost our politicians the printing press,
but thanks to low EUR rates, the government could now service previously unthinkable
amounts of debt with impunity. A residual part of that money may have ended up in useful
projects, but the bulk ended up in the pockets of the twenty families who run Greek business.
A big chunk of that money, in turn, has been invested by these families in bringing to Greece
every foreign franchise from Starbucks and Pizza Hut to IKEA and Stanley Kaplan, driving
existing companies out of business in the process. In summary, EU funds have done to Greece
what oil did to Nigeria, while low EUR rates have allowed the government of Greece to be able
to service a debt of 100% of GDP, most of which has gone straight to the pockets of the
oligarchy. Man on the street, with the exception of the farmers, has not benefited one jot. This
does not make all Greeks poor. Shipowners do very well, and a natural resource called the sun
is very helpful to our 165,000 hoteliers. Man on the street never saw the benefit of the 250
billion the government has borrowed. Ergo, support for austerity now that the bill has come is
zero. You wont see anybody accept an Irish solution in Greece.
The notion that Brussels will dictate to Greece terms on public sector wages and impose a May

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deadline are, frankly, comical. The government may like the idea, but the entire population will
probably go on strike. Needless to say, Greece can pay. If the government chooses to freeze
savings accounts it can pay the whole kahuna in one go. But the Greek people will refuse to
take any hardship. This is a matter between some French and German baby-boomers, their
government, and twenty Greek families who will happily take more. I hope we default and the
country is freed from the curse of free money that befell it in 1980. Once our politicians have no
more money to disburse to the oligarchs, we can start to be proud Europeans.
Related posts:
1. Sovereign Defaults, Greece, etc. A Live Chat
2. Readings: Greece, Coal, Solar, Cows, and China
3. Niall Ferguson: Solution to Debt Crisis Isnt More Debt
4. Ferguson: Cancel U.S. Debt
5. Debt is the New Equity. Discuss.
Readings: China, Jobs, Credit, etc.
The Future of Public Debt
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