PIIGS: Too Big to Fail

The largest economy in the world, The United States of Europe, officially called the European Union is facing a financial crisis that could weigh down our own economic recovery.  The bears on Wall Street have outnumbered the bulls, focusing on the economic upheaval in Europe instead of the good economic news here at home.  Economic indicators here in the U.S. are still pointing upwards indicating the continuation of our recovery from the great recession.  Housing starts rose an estimated 5.8% in April to an annual rate of 672,000; retail sales were up 0.4% beating expectations; industrial production moved higher; 1st quarter earnings of 75% of companies in the S&P 500 have exceeded expectation and most notably, the private sector added 32,000 jobs according to ADP.  Various economists differ in their projection of job growth this year, from a low of 300,000 to a high of 1 million private sector jobs.  I believe that the extension of unemployment and health benefits is a disincentive for many unemployed workers to seek work, thereby contributing to the high unemployment rate which has been hovering around 10%.

The malaise in Europe is hard to ignore because our global economies are all inter-connected.  The failure of any of the EU’s most ailing economies, the PIIGS which is an acronym for Portugal, Ireland, Italy, Greece and Spain could send a tsunami of global economic woe: a financial meltdown much worse than the sub-prime mortgage crisis of 2008.  The PIIGS are less affluent countries than their northern neighbors such as Germany and France and there is such a disparity of wealth between member nations.  The IMF/European Debt Bailout of 750 billion Euros, which has been nicknamed “Le TARP”, pacified the market early last week so the bulls started running again driving up the Dow Jones Industrial Averages (DJIA) 500 points from the previous week’s low of 10,380.  As reality sank in, investors became jittery and gravitated towards tangible investments such as gold, driving up its price to $1220 an ounce.

Reality is that Greece will eventually default.  It is my educated opinion based on facts.  Greece is the second most corrupt developed country in the world according to Forbes Magazine.  It is easy to bribe Government officials.  It is a social democracy, a welfare state with generous entitlement programs which includes early retirement, state pensions, and huge bonuses for public employees and a generous cradle to grave health care system.   The wealthiest members of society, shipping magnates like Onassis, lawyers, doctors and other highly paid professionals have traditionally avoided paying direct taxes.  I do not think the Greek populace can swallow the austerity measures being currently debated by the Greek parliament.  Public anger in Greece will continue running at explosive levels. Why should the Greeks agree to do away with their entitlements which have been their way of life for such a long time?  Besides, most Greeks do not blame themselves nor their government for their predicament.  Rather, many Greeks would argue that the U.S. caused the financial meltdown leading to the severe world wide recession and banking crisis. Greece’s accumulated deficit is running 113% of GDP.  They have ran out of money to pay for their bonds that are coming due.  The solution is to issue more long term bonds to raise money but their government bonds have been downgraded making it impossible to sell them to continue to finance deficit spending.

Austerity measures being proposed include the freezing of government pay till 2014; dispensing with the 2-month bonus for public employees; increasing of the retirement age from 61 to 63; increasing VAT (Value Added Tax) from 19 to 23%.  It is reported that 1/3 of the Le TARP money or 250 Euros will come from the International Monetary Fund (IMF) out of which 10 billion Euros is the contribution of the U.S.

Volcker’s statement last week that the Euro may break up, points to the core of the problem of the European Union. The Euro has gone down from its high of $1.50 per Euro last November to a low of $1.24 this week.   The problem is that on one hand, member countries have become financially responsible for each other as magnified by this crisis.  On the other hand, member countries have very little influence on how another country is governed because each member is an indivisibly sovereign state. At least if Greece goes back to its own currency, the drachma, it will suffer on its own for its fiscal irresponsibility.  This current crisis is testing the EU if it can stay united and if the Euro will be preserved.

The 750 billion Euros may not be enough to rescue Greece.  It certainly will not be enough to bail out other PIIGS in case any of them defaults on their external debts.  If one falls, it would be followed by another and another and another.  And this is what worries me and makes me bearish on the market despite the good economic reports in this country.

This article is not intended to provide financial advice.  Please consult your financial advisor before acting on any advice provided herein.

Any opinions and views expressed herein are the sole responsibility of the writer.

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