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Sep 13

Is the Greece Default Immanent? (And What You Can Learn from it)

Posted by abiao at 15:29 | News | Comments(4) | Reads(7268)
If you have spent any time following the story playing out in Europe you know that many of the Eurozone countries are experiencing the same crisis that the United States went through in 2009. If we strip away all of the economic and political chatter, the story is simply this: Because of a whole lot of bad financial decisions, many Eurozone countries are on the brink of disaster and no country is closer to financial Armageddon than Greece.

greece eurozone crisisStill, although Greece is essentially bankrupt, Americans in large numbers have no idea the tragedy that continues to unfold in this small country. Why is Greece in this position, what happens if they default on their debts, and what can we learn from these events?

The Story
The story is full or drama and history but much of the problem comes from the fact that Greece hasn’t done a good job of taxing its citizens. The New York Times reports that Greece has allowed large amounts of citizens and companies to evade their tax liabilities. The same report says that if these taxes were collected, Greece would be able to meet much of their liabilities but suddenly raising taxes on their citizens isn’t practical either. Others note that in Greece’s own budget, government spending now exceeds 50% of GDP, the total value of all goods and service sold in the country.

This means that half of the total production of goods and services funds current spending. The rest of the budget, which includes a lot of uncollected revenue, pays on the debt but it’s not nearly enough. The European Central Bank has been left with the task of paying for Greek debt which is mounting fast largely because the interest rates they have to pay to borrow money is so high. Recently the interest rate Greece has to pay has passed 50%. Eurozone countries no longer want to let Greece borrow money so they are left to pay their debt with money they don’t have.

Will They Default?
It’s hard to find anybody who follows the Eurozone crisis who thinks that Greece won’t default. Without finding another source of funds, they are effectively out of money and have no plausible way of making it through September without defaulting.

If they do default, expect a severely negative response in the world financial markets and that means even more pressure on your retirement accounts. Some economists believe that this event alone may be what sends the United States in to a second recession. Of course everybody hopes that the Eurozone finds a way to keep Greece out of default but it doesn’t look promising. The worst case scenario could play out.

What can You Learn?

If it can happen to Greece, it can happen to you. When you spend more money than you take in, you eventually lose the ability to make the payments. Greece is proof that everything we’ve heard about debt is true even if you’re a country. Debt is dangerous and just because you think you have it under control today doesn’t mean that an unexpected event won’t happen tomorrow that allows it to overtake you and your family. If the worst case scenario plays out and a Greek default sends the United States in to recession, could that be the event that causes you to lose your job? Could you still make your debt payments?

The lesson to take away from the Greece crisis is to always plan for the worst case scenario and leave a financial cushion firmly in place.

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Well the truth is somewhat more complex! Greece's debt is inevitably connected with large institutions and countries around the world. The only reason Greece has not defaulted yet is the fact that if Greece defaults a great number of players in the financial system will have tremendous consequences... A bunch of people agree that Greece will eventually default but the case here is that Greece has already defaulted. However, the default of Greece does not follow the standard definition of missed payments but a somewhat ligher one, this of selective default. This is that payments to the Greek people from the government will be missed, but the Eurozone and the global economy take every penny they lended back. However the lesson is rather twofold: you should keep some money for the worst-case scenario, but you should also be very careful to who you lend your money in. It was the promised high interest rates that make people want to finance Greece and it is the same high interest rates that "force" Eurozone to lend Greece and do not let the country default. If you add the speculation around the Greek default with the CDS's you have the right scenario played there. And a concluding remark for the CRA's, if credit rating are procyclical as they are advertised to be, please have a look of the credit rating for Greece at 2008.
abiao replied on 2011/09/14 08:11
thanks for ur added comment, it makes sense.
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