- Money Morning Australia

Prepare for a Default


Written on 03 October 2011 by Greg Canavan

Prepare for a Default

According to Reuters, the new Greek austerity plan has fallen short of the mark. The Greek Finance Ministry approved a draft budget for a deficit of 8.5% of Greece’s gross domestic product (GDP) in 2011 and 6.8% of GDP in 2012.

Trouble is it does not meet the targets set by the European Union (EU) and International Monetary Fund (ECB)… Which were 7.6% for 2011 and 6.5% for 2012. The plan is so far off the mark that Greece needs almost two billion more euros to finance its expenses for the rest of this year.

Greece has asked for €8 billion as part of the bailout package promised by representatives of the European Central Bank (ECB), IMF and EU (a group known as the Troika)… But the Troika needs to approve the release of the loans.

Greece has promised to raise taxes, cut state wages and speed up plans to cut the number of public sector workers by 20% by 2015. (That’s 30,000 workers.)

The problem, according to the Associated Press, is ‘Greece has “exhausted” its ability to pay more taxes to cover budget gaps, the deputy prime minister declared Wednesday, saying he himself can’t pay a new emergency tax without selling property.’

If the Troika doesn’t release the loans, according to reports in the Associated Press, Greece could be broke by mid-October.

Luckily for the Greeks, the Germans are feeling generous. Last Thursday, the German parliament voted for… (523 for, 85 against, 3 abstentions)… increasing the size and flexibility of the euro-zone rescue fund…

But I believe the inevitable will happen and you should prepare for a Greek default.

The ramifications will be short-term negative but long-term positive. There will be panic selling. If you want to benefit from it, it would be good to have some cash on hand.

There are many different scenarios that could come out of a Greek default. The best will be an orderly default. This is where the authorities accept the inevitable and plan for the consequences. There are indications that Germany is already doing this. But planning needs to be coordinated and widespread.

If Greece defaults there will be major ramifications for the global banking system. The inter-connected nature of global banking (especially through derivatives) means no one knows how the situation would unfold.

And if Greece defaults, what happens to Spain, Portugal and Ireland? Surely they would want some debt relief too? This would mean bigger hits for the global banking system.

In such a scenario, what happens to the Eurozone? Greece needs a much lower currency in order to regain competiveness and balance the books. No one will lend to Greece if it returns to the Drachma…but no one is lending now except for emergency funds. And there is no reason why these shouldn’t remain until Greece stabilises its economy.

There has been talk that the euro should break into two. Germany and the northern creditor nations would form the ‘strong’ euro while France and the southern debtor nations would adopt a weaker euro.

This would cause much short-term pain as it would impact the competitiveness of Germany. But it would go a long way to rebalancing Europe’s lopsided trade.

There are solutions – not without pain of course – but my feeling is the pain will be too much for the bankers and politicians to bear. If you think about the above scenario, the short-term upheaval will threaten the power bases of many of the world’s elites. Banks will need to be recapitalised (wiping out billions in shareholder wealth) and governments will be voted out.

The next few months won’t be a case of what should be done for the sake of economic progress, but what will be done to maintain the status quo and existing power structures.

What we have then is a situation where the natural forces of the market are trying to force a default on Greece, while the authorities are doing everything in their power to resist it. The chances are that a default will be disorderly.

The probability is increasing that we experience a disorderly event in the next few months. If I was certain of this outcome, I would suggest moving to 100 per cent cash and gold bullion. But there are no certainties in life or in markets.

Although events in Europe might not seem to have much relevance to you, where a threat to the global banking system is involved, believe me, they do.

While this scenario continues to unfold, I think the best strategy is to continue to identify attractively priced companies to put on your watchlist for future investment.

If you’d like to see which attractively priced companies I’m recommending to Sound Money. Sound Investments subscribers right now, please click here.

Greg Canavan
Money Morning Australia



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Greg Canavan

Greg Canavan

Greg Canavan is a feature Editor at The Daily Reckoning Australia and is the foremost authority for retail investors on value investing in Australia. He is also the author of Sound Money. Sound Investments (SMSI). An investment publication designed to help investors profit from companies and stocks that are undervalued on the market. If you're already a subscriber to these publications, or want to follow Greg's financial world view more closely, then we recommend you join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.

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1 Comments For This Post

  1. gnbi Says:

    prepare for a default and get on with it..borrowing more money to get out debt is not the solution.



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