You are probably sick of me (and everyone else) talking about Greece. Will they or wont they pay? Why won’t they agree to more austerity measures? Why do the Europeans want to keep them in the Union? Why don’t they just default?
These are all valid questions and ones you should be concerned with. Believe it or not, it is a significant problem for investment markets, and therefore you.
And if you don’t think of yourself as an “investor”, think again.
If you work in Australia, you have at least 9.5% of your wage being paid into a superannuation fund. Whether that’s an Industry fund, a Wrap product, or you have set up a Self Managed Super Fund (SMSF), you’re officially an investor. And that means you’re retirement income is affected by what is happening around the world.
As advisors, we use the (not so) “dark art” of asset allocation to generate reliable and repeatable returns for your portfolio. It’s a process, and it is all done within a framework of risk management. We blend different assets with different income and growth characteristics to build a portfolio. Some portfolios have more growth, and others have less – it depends on your risk appetite.
Bonds are income producing assets, and are used as an “anchor” in your portfolio. They are meant to keep the amount of money you have invested protected (your capital), and generate a predictable cashflow (income). If you are more risk averse, you are likely to have more bonds/fixed income in your portfolio.
Greece joined the Euro in 2001. They agreed to a common currency with a bunch of rules attached as to how to run their economy (even though the nation was already running an unhealthy debt/GDP ratio of 96%).
After joining the EU, Greece moved from double digit interest rates and the Drachma, to cheap money with low single digits. As you’d expect, this let to a spending binge. Greece won the right to host the 2004 Olympics, and added another €9b to the stack. Economic activity increased, and helped reduce the unemployment rate from just over 12% to a low of 7.3% in 2008. Civil servant wages accounted for around 80% of the national budget. Incomes per person rose from $13,180 to $29,060 (source World Bank) in 2009, a massive 120% increase.
Germany was happy to have some weaker economies join the Union and common currency, as their goods and services automatically became cheaper with a weaker currency (compared to the Deutschemark). Germany was able to maintain current account surpluses, sell products and services to Greece, thereby increasing the IOUs. German incomes per capita rose from $26,170 to $43,810, a 67% increase to 2009.
As Greece’s debts rose so did other costs which were now Euro denominated. Greece was becoming less competitive in shipping, tourism, and agriculture – their chief exports. Corruption was rife in Defence & Health department procurement, tax collectors didn’t collect tax, pensions were generous… all was good. Or was it?
In 2009 as part of the fallout from the Global Financial Crisis, the PIIGS (Portugal, Ireland, Italy, Greece, & Spain) were caught in a sovereign debt crisis. The “one size fits all” monetary policy of the Eurozone had pushed the PIIGS to the limit. In 2010, the Greek government promised to cut the deficit by 4%, agreed to some other austerity measures and received a €80b bailout from the EU, and a further €30b from the IMF.
Austerity measures included wage cuts, tax hikes and pension reform, and the Government was forced to spend less and save. 1 in 4 became unemployed, the Greek economy not only slowed, but contracted. This caused Greece’s debt/GDP ratio to rise to 148% in 2011 (now 177% in 2015).
Greece is now faced with a mounting welfare bill (expense) and shrinking tax base (revenue) as 25% unemployment and 50% youth unemployment take their toll.
In 2015, they are under pressure to repay EU, ECB, & IMF loans. They can sell assets (eg the Port of Piraeus), but that is unlikely to put a dent in the €300b+ debt pile.
This means Greece will either:
When talking of a “haircut”, it is essentially a debt restructure. In 2010, Greece asked for assistance in their escalating borrowings. In 2012 a debt exchange was negotiated which extended maturities, lowered interest rates, and slashed 53% off the face value of the bonds. This allowed Greece to write off €100b from its debts of €350b.
Capital controls might be imposed to help stymie the flow of money out of Greek banks, and keep them capitalised. Greeks have been moving money out of their banks (and the country) in the billions. They’ve also been buying hard portable assets like cars in recent months, with April registrations up 47%, and May 27%.
Last week was looking promising in terms of a deal. The Greeks said they had something, and the Europeans were prepared to accept just one more austerity commitment to release funding. However hopes were dashed on Friday, with the IMF walking out the door, along with depositors pulling €500m out of Greek banks in a day.
The Greeks have already had 5 years of recession, incomes are now 30% lower, and youth unemployment is around 50%. They only account for around 2% of the EU (Germany is the largest at about 28%).
The “stable” part of most people’s portfolios is reacting to this situation (as are equities). Bond yields are rising and triggering losses. Credit risk is also playing a part, as “Private Investors” (ie pension/super funds, insurance companies, banks) either own some of Greece’s debt directly or indirectly through other European Government bonds (see pie chart below).
We are getting closer to crunch time (July/August), and I suspect option 2 will be more palatable. Expect some further volatility, and watch events with interest, as at the very least your retirement plans may be affected.
