But the original problem - too much debt - hasn't gone away. It has just been transferred to government balance sheets.

Time to give up debt addiction

GREG HOFFMAN
May 17, 2010 - 2:12PM

The first week of May's panicked trading on world financial markets was eerily reminiscent of the post-Lehman chaos of September 2008. Equity markets plummeted, debt markets froze and inter-bank lending rates skyrocketed.

The question is not whether Greece can or cannot pay its debts (without dramatic cuts to government spending, it looks nigh on impossible), but which country is next.

With Spain, Portugal and Ireland in the firing line, it's no wonder banks are reluctant to lend to each other. It's also no surprise that the European Union (EU) and International Monetary Fund (IMF) have orchestrated a 750 billion euros ($1 trillion) rescue package.

The Europeans, being European, took their time. But, not surprisingly for students of human nature or politics, they've taken the easy option and kicked the can down the road. For now, another crisis has been avoided.

In hock

For more than a decade, Western consumers borrowed too much money, ably assisted by financial institutions creating financial products they themselves didn't understand. When the consumers couldn't pay and the banks were about to collapse, governments bailed them out. Remember the calls for a "global stimulus package"'?

Well, it worked in as far as we're not looking down the barrel of another Great Depression. Amongst the recent chaos, statisticians announced that the US economy generated an astonishing 290,000 jobs in April.

But the original problem - too much debt - hasn't gone away. It has just been transferred to government balance sheets. Now, one of those governments can't meet its obligations. So what do we do? We just transfer the problem onto bigger balance sheets. In this case, they're the ones owned by the EU and the IMF.

The buck, however, can't get passed any further. Europe and the US are not too big to fail, but they are too big to bail. It is going to hurt but eventually, eventually, the Western world needs to reduce the overall leverage in the system. And what form might that take?

How to deleverage

McKinsey and Co, a consulting company, recently produced an insightful analysis of 45 prior episodes of deleveraging, 32 of which followed financial crises. The authors conclude that there are four ways to deleverage an economy, and only two of those options are available to the West today.

The two options are inflation and "belt tightening". The latter has been the most common tonic to a bout of indebtedness (16 of the 32 post-crisis deleveraging episodes).

This means cutting back on government spending in order to bring spiralling foreign debt balances under control and the result, in all cases, was a substantial reduction in economic growth.

Inflation might seem like a far more palatable solution and, for creditors, there's no doubt it is. Perhaps best described as "default by stealth", inflation erodes the value of debts and, if you're the supposed recipient of those debts, the value of your assets.

Inflation also reduces the value of all other assets in an economy, creates substantial frictional costs and destroys a country's ability to borrow in its own currency again.

It might be the most palatable option for a leveraged electorate, but for the owners of capital, inflation is a disaster. And once the inflation genie is out of the bottle it can be very difficult to get it back in.

As investors, we should be preparing for one or both of these factors to have a substantial impact on our portfolios over the coming decade. In many ways, however, we should welcome it. It's in everyone's interests to unwind imbalances in global trade and fiscal budgets and so begin the process of Western deleveraging. Otherwise we run the risk of a crisis so big it might portend another Great Depression. From my perspective, the sooner the better.

This article contains general investment advice only (under AFSL 282288).

Greg Hoffman is research director of The Intelligent Investor

http://www.smh.com.au/business/time-to-give-up-debt-addiction-20100517-v84t.html

Financial success? Debt-free

Many Americans have redefined the meaning of financial success in the post recession era, to be debt-free.

Greece, the Latest and Greatest Bubble

MARCH 11, 2010, 6:44 AM
Greece, the Latest and Greatest Bubble

By PETER BOONE AND SIMON JOHNSON

Bubbles are back as a topic of serious discussion, as they were before the financial crisis. The questions today are:
(1) Can you spot bubbles?
(2) Can policy makers do anything to deflate them gently?
(3) Can anyone make money when bubbles get out of control?

Our answers are:
(1) Spotting pure equity bubbles may sometimes be hard, but we can always see unsustainable finances supported by cheap credit. 
(2) Policy makers will not act because all great (and dangerous) bubbles build their own political support; bubbles are invincible, until they collapse. 
 (3) A few investors can do well by betting against such bubbles, but it’s harder than you might think because you have to get the timing right — and that’s much more about luck than skill.

Bubbles are usually associated with runaway real estate prices or emerging market booms or just the stock market gone mad (remember Pets.com?). But they are a much more general phenomenon — any time the actual market value for any asset diverges from a reasonable estimate of its “fundamental” value.

To think about this more specifically, consider the case of Greece today. It might seem odd to suggest there is a bubble in a country so evidently under financial pressure, and working so hard to stave off collapse with the help of its neighbors.

But the important thing about bubbles is: Don’t listen to the “market color” (otherwise known as ex-post rationalization); just look at the numbers.

By the end of 2011 Greece’s debt will be around 150 percent of its gross domestic product. (The numbers here are based on the 2009 International Monetary Fund Article IV assessment.) About 80 percent of this debt is foreign-owned, and a large part of this is thought held by residents of France and Germany. Every 1 percentage point rise in interest rates means Greece needs to send an additional 1.2 percent of G.D.P. abroad to those bondholders.

Imagine if Greek interest rates rise to, say, 10 percent. This would be a modest premium for a country with the highest external public debt/G.D.P. ratio in the world, a country that continues (under the so-called austerity program) to refinance even the interest on that debt without actually paying a centime out of its own pocket, while struggling to establish any backing from the rest of Europe. At such interest rates, Greece would need to send at total of 12 percent of G.D.P. abroad per year, once it rolls over the existing stock of debt to these new rates (nearly half of Greek debt will roll over within three years).

This is simply impossible and unheard of for any long period of history.

German reparation payments were 2.4 percent of gross national product from 1925 to 1932, and in the years immediately after 1982 the net transfer of resources from Latin America was 3.5 percent of G.D.P. (a fifth of its export earnings). Neither of these were good experiences.

On top of all this, Greece’s debt, even under the International Monetary Fund’s mild assumptions, is on a non-convergent path even with the perceived “austerity” measures. Bubble math is easy. Hide all the names and just look at the numbers. If debt looks as if it will explode as a percent of G.D.P., then a spectacular collapse is in the cards.

Seen in this comparative perspective, Greece is still going bankrupt unless it gets a great deal more European assistance or puts a much more drastic austerity program in place. Probably it needs both.

Given that there’s a definite bubble in Greek debt, should we expect European politicians to help deflate this gradually?

Definitely not. In fact, it is their misleading statements, supported in recent days (astonishingly) by the head of the International Monetary Fund, that keep the debt bubble going and set us all up for a greater crash later.

The French and Germans are apparently actually encouraging banks, pension funds and individuals to buy these Greek bonds — despite the fact senior politicians must surely know this is a Ponzi scheme (i.e., people can get out of Greek bonds only to the extent that new investors come in).

At best, this does nothing more than postpone the crisis. In the business, it is known as “kicking the can down the road.” At worst, it encourages less informed people (including perhaps pension funds) to buy bonds as smarter people (and big banks, surely) take the opportunity to exit.

While French and German leaders make a great spectacle of wanting to end speculation, in fact they are encouraging it. The hypocrisy is horrifying. President Nicolas Sarkozy of France and Chancellor Angela Merkel of Germany are helping realistic speculators make money on the backs of those who take misleading statements by European politicians seriously. This is irresponsible.

What should be done? In three steps:

1. The Greeks and the Europeans must decide: Do they want to maintain the euro as Greece’s currency, or not?

2. If they want to keep the euro in Greece, the Greeks need to come up with realistic plan to start repaying debt soon. Any Greek plan will not be credible for the first few years, so the Europeans must finance the Greeks fully. This does not mean spending 20 billion euros; rather, it means making available around 180 billion euros, that is, the full amount of refinancing that Greece needs during this period.

3. If they don’t want to keep the euro, then they should start working now on a plan for Greece’s withdrawal. The northern Europeans will need to bail out their own banks, because Greek debt must fall substantially in value. Euro-denominated debt will need to be written down substantially or converted to drachmas so it will be partially inflated away. The Greeks can convert local contracts, and deposits at banks, to drachmas. It will be a very messy, difficult transition, but the more the debt bubble persists, the more attractive this becomes as a “least awful” solution.

Regardless of the decision on whether Greece will keep the drachma or give it up, the I.M.F. should be brought in to conduct the monitoring and burden share.

The flagrant deception that we now observe — as the Europeans claim that the Greeks have taken a big step forward, and encourage people to buy Greek bonds — proves they do not have the political capacity to be realistic about this situation. Who can now be believed when it comes to discussing needs for Greek financial reform and formulating a credible response?

The only credible voice left with the capacity to act is the I.M.F. — and even that body risks being compromised by the indiscreet statements of its top leadership as the bubble continues.

If such measures are not taken, we are clearly heading for a train wreck. The European politicians have been tested, and now we know the results: They are not careful. They are reckless.

Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics. He is also a principal in Salute Capital Management Ltd. Simon Johnson, a senior fellow at the Peterson Institute for International Economics, is the former chief economist at the International Monetary Fund.


http://economix.blogs.nytimes.com/2010/03/11/greece-the-latest-and-greatest-bubble/

Greek Debt Woes Ripple Outward, From Asia to U.S.

The fear that began in Athens, raced through Europe and finally shook the stock market in the United States is now affecting the broader global economy, from the ability of Asian corporations to raise money to the outlook for money-market funds where American savers park their cash.

“Greece may just be an early warning signal,” said Byron Wien, a Wall Street strategist. Above, the Acropolis in Athens.

What was once a local worry about the debt burden of one of Europe’s smallest economies has quickly gone global. Already, jittery investors have forced Brazil to scale back bond sales as interest rates soared and caused currencies in Asia like the Korean won to weaken. Ten companies around the world that had planned to issue stock delayed their offerings, the most in a single week since October 2008.

The increased global anxiety threatens to slow the recovery in the United States, where job growth has finally picked up after the deepest recession since the Great Depression. It could also inhibit consumer spending as stock portfolios shrink and loans are harder to come by.

“It’s not just a European problem, it’s the U.S., Japan and the U.K. right now,” said Ian Kelson, a bond fund manager in London with T. Rowe Price. “It’s across the board.”

The crisis is so perilous for Europe that the leaders of the 16 countries that use the euro worked into the early morning Saturday on a proposal to create a so-called stabilization mechanism intended to reassure the markets. On Sunday, finance ministers from all 27 European Union states are expected to gather in Brussels to discuss and possibly approve the proposal.

The mechanism would probably be a way for the states to guarantee loans taken out by the European Commission, the bloc’s executive body, to support ailing economies. European leaders including the French president, Nicolas Sarkozy, said Saturday morning that the union should be ready to activate the mechanism by Monday morning if needed.

In Spain Saturday, Vice President Joseph R. Biden Jr. underscored the importance of the issue after meeting with Prime Minister José Luis Rodríguez Zapatero. “We agreed on the importance of a resolute European action to strengthen the European economy and to build confidence in the markets,” Mr. Biden said. “And I conveyed the support of the United States of America toward those efforts.”

Beyond Europe, the crisis has sent waves of fear through global stock exchanges.

A decade ago, it took more than a year for the chain reaction that began with the devaluation of the Thai currency to spread beyond Asia to Russia, which defaulted on its debt, and eventually caused the near-collapse of a giant American hedge fund, Long-Term Capital Management.

This crisis, by contrast, seemed to ricochet from country to country in seconds, as traders simultaneously abandoned everything from Portuguese bonds to American blue chips. On Wall Street on Thursday afternoon, televised images of rioting in Athens to protest austerity measures only amplified the anxiety as the stock market briefly plunged nearly 1,000 points.

“Up until last week there was this confidence that nothing could upset the apple cart as long as the economy and jobs growth was positive,” said William H. Gross, managing director of Pimco, the bond manager. “Now, fear is back in play.”

While the immediate causes for worry are Greece’s ballooning budget deficit and the risk that other fragile countries like Spain and Portugal might default, the turmoil also exposed deeper fears that government borrowing in bigger nations like Britain, Germany and even the United States is unsustainable.

“Greece may just be an early warning signal,” said Byron Wien, a prominent Wall Street strategist who is vice chairman of Blackstone Advisory Partners. “The U.S. is a long way from being where Greece is, but the developed world has been living beyond its means and is now being called to account.”

If the anxiety spreads, American banks could return to the posture they adopted after the collapse of Lehman Brothers in the fall of 2008, when they cut back sharply on mortgages, auto financing, credit card lending and small business loans. That could stymie job growth and halt the recovery now gaining traction.

Some American companies are facing higher costs to finance their debt, while big exporters are seeing their edge over European rivals shrink as the dollar strengthens. Riskier assets, like stocks, are suddenly out of favor, while cash has streamed into the safest of all investments, gold.

Just as Greece is being forced to pay more to borrow, more risky American companies are being forced to pay up, too. Some issuers of new junk bonds in the consumer sector are likely to have to pay roughly 9 percent on new bonds, up from about 8.5 percent before this week’s volatility, said Kevin Cassidy, senior credit officer with Moody’s.

To be sure, not all of the consequences are negative. Though the situation is perilous for Europe, the United States economy does still enjoy some favorable tailwinds. Interest rates have dropped, benefiting homebuyers seeking mortgages and other borrowers. New data released Friday showed the economy added 290,000 jobs in April, the best monthly showing in four years.

Further, crude oil prices fell last week on fears of a slowdown, which should bring lower prices at the pump within weeks. Meanwhile, the dollar gained ground against the euro, reaching its highest level in 14 months.

While that makes European vacations more affordable for American tourists and could improve the fortunes of European companies, it could hurt profits at their American rivals. A stronger dollar makes American goods less affordable for buyers overseas, a one-two punch for American exporters if Europe falls back into recession. Excluding oil, the 16 countries that make up the euro zone buy about 14 percent of American exports.

For the largest American companies, which have benefited from the weak dollar in recent years, the pain could be more acute. More than a quarter of the profits of companies in the Standard & Poor’s 500-stock index come from abroad, with Europe forming the largest component, according to Tobias Levkovich, Citigroup’s chief United States equity strategist. All this could mean the difference between an economy that grows fast enough to bring down unemployment, and one that is more stagnant.

The direct exposure of American banks to Greece is small, but below the surface, there are signs of other fissures. Even the strongest banks in Germany and France have heavy exposure to more troubled economies on the periphery of the Continent, and these big banks in turn are closely intertwined with their American counterparts.

Over all, United States banks have $3.6 trillion in exposure to European banks, according to the Bank for International Settlements. That includes more than a trillion dollars in loans to France and Germany, and nearly $200 billion to Spain.

What is more, American money-market investors are already feeling nervous about hundreds of billions of dollars in short-term loans to big European banks and other financial institutions. “Apparently systemic risk is still alive and well,” wrote Alex Roever, a J.P. Morgan credit analyst in a research note published Friday. With so much uncertainty about Europe and the euro, managers of these ultra-safe investment vehicles are demanding that European borrowers pay higher rates.

These funds provide the lifeblood of the international banking system. If worries about the safety of European banks intensify, they could push up their borrowing costs and push down the value of more than $500 billion in short-term debt held by American money-market funds.

Uncertainty about the stability of assets in money market funds signaled a tipping point that accelerated the downward spiral of the credit crisis in 2008, and ultimately prompted banks to briefly halt lending to one other.

Now, as Europe teeters, the dangers to the American economy — and the broader financial system — are becoming increasingly evident. “It seems like only yesterday that European policy makers were gleefully watching the U.S. get its economic comeuppance, not appreciating the massive tidal wave coming at them across the Atlantic,” said Kenneth Rogoff, a Harvard professor of international finance who also served as the chief economist of the International Monetary Fund. “We should not make the same mistake.”

James Kanter contributed from Brussels.

http://www.nytimes.com/2010/05/09/business/global/09ripple.html?src=me&ref=business

Global Financial Crisis II

Fears that the Greek debt crisis could drag down the world economy

More market turmoil looms
PHILIP WEN
May 10, 2010

AFTER a horror week during which $90 billion was wiped off the Australian sharemarket, investors are bracing themselves for more financial market turmoil over the mounting debt crisis in Europe.

Australian stocks fell 7 per cent last week, the worst weekly loss since November 2008. And the worst may not be over, with the SPI futures index pointing to further losses today, following more losses across all major global indices.

With markets worldwide taking a battering, European leaders have scrambled into action as fears intensify that the spread of the region's debt woes could pitch the world back into a recession.

''The problem now is contagion risk and where will it stop,'' said credit markets expert Philip Bayley, of ADCM Services. ''The markets fear that we are now entering the second leg of the global financial crisis - GFC II.''

Fears that a debt default by Greece could paralyse the world's financial system - just as the collapse of Lehman Brothers did two years ago - sparked another wave of heavy selling on European and US markets on Friday.

Treasurer Wayne Swan said Australia was better placed than any other advanced economy to deal with any global slowdown caused by the sovereign debt crisis in Greece. Mr Swan will hand down his third budget tomorrow.

His comments followed the Reserve Bank of Australia last week cautioning that the economy could be buffeted by global fallout.

The market plunge could have serious ripple effects through its impact on confidence.

Some of the nation's major banks were believed to be looking over the weekend at measures to keep holdings of liquid assets topped up given increased risk on European credit markets.

Even home buyers appeared to be responding to global jitters. Melbourne's property market recorded its second lowest auction clearance rate so far this year, the figure dropping to 78 per cent on the weekend.

REIV chief executive Enzo Raimondo said the six rate rises, affordability concerns and the unseasonably high stock levels were all having an impact on demand. On Friday, euro zone governments approved the $A160 billion Greek bailout package, in a last-ditch effort to keep the nation afloat.

But markets were unconvinced. The Dow Jones shrugged off stronger than expected US jobs data to close 1.3 per cent lower.

In Britain, shares fell 2.6 per cent - a result exacerbated by uncertainty over the British general election.

The cost of protecting European bank debt against default has reached levels not seen since the height of the global financial crisis. Bond yields soared in Portugal and Spain, while the failure to constrain the debt crisis led to the euro plunging 4.3 per cent last week. Portugal, Ireland, Italy, Greece and Spain collectively owe $US3.9 trillion ($A4.39 trillion) to other countries.

Apart from Australian banks' $A56.4 billion in exposure to Europe at the end of December, most analysts say the economy has few other direct links to the troubled region.

US President Barack Obama admitted he was ''very concerned'' about the debt crisis. Understandably so, given the extreme volatility in US markets last week, including an extraordinary 10 per cent intra-day plunge on Thursday. The Dow Jones index retreated 6.4 per cent last week, the heaviest decline since March 2009. Wall Street's so-called ''fear gauge'', the CBOE volatility index, jumped 25 per cent in the same period.

ADCM's Mr Bayley said markets were pointing to a Greek debt default as an ''all but foregone conclusion'', with the rescue package likely to have little impact.

With NATALIE PUCHALSKI

Source: The Age

http://www.smh.com.au/business/more-market-turmoil-looms-20100509-ulse.html

US stocks dive as Greek crisis takes toll

US stocks dive as Greek crisis takes toll
May 5, 2010 - 6:35AM

Overseas markets in crash mode
The DJIA was down by 2.0 per cent, and the S&P500 down by 2.4 per cent after heavy selling on

Investors dumped US stocks in Wall Street's worst session in three months on the fear that even with a bailout for Greece, Europe's debt crisis could spread to other weak euro zone countries.

The sell-off echoed a wave of fear that gripped financial markets as investors fretted the crisis in Europe could derail the global economic recovery. A gauge of investor fear jumped more than 18 per cent.

What you need to know
The SPI was off 104 points at 4630
The Australian dollar was buying 90.89 US cents
The Reuters Jefferies CRB index fell 2.34%

Big exporters to Europe including technology and industrial companies tumbled, with Hewlett-Packard off 3.9 per cent to $US50.64 and Caterpillar down 4.6 per cent to $US66.70.

"It looks like we've got some profit-taking on early-cycle exporters, companies with a big global presence over in Europe," said Fred Dickson, chief market strategist at D.A. Davidson & Co in Lake Oswego, Oregon.

Basic materials shares tumbled as the euro hit a one-year low against the US dollar. The Reuters-Jefferies commodity index and the S&P materials index both posted their worst day since early February, sliding 2.3 per cent and 3.5 per cent, respectively.

The Dow Jones industrial average lost 225.06 points, or 2.02 per cent, to 10,926.77. The Standard & Poor's 500 Index fell 28.66 points, or 2.38 per cent, to 1173.60. The Nasdaq Composite Index dropped 74.49 points, or 2.98 per cent, to 2424.25.

The CBOE Volatility Index, Wall Street's so-called fear gauge, finished up 18.1 per cent at 23.84 points, its highest closing level in three months.

Airline shares were hard hit, with the Arca Airline Index shedding 5.39 per cent after a recent run-up.

Despite the S&P 500's steep fall, the benchmark did not break major technical support except for a short-term bottom at 1181 on the S&P 500, the intraday low hit last week.

"For initial support most people are watching the 50-day moving average, which is at 1168," said John Schlitz, chief US market technician at Instinet in New York.

Encouraging US economic data on manufacturing and housing failed to provide a floor to the market. Reports showed new orders received by US factories in March unexpectedly increased and pending home sales rose to a five-month high.

On the upside, better-than expected earnings from drug makers Merck & Co Inc and Pfizer Inc boosted those shares by about 2 per cent each.

About 12 billion shares traded on the New York Stock Exchange, the American Stock Exchange and Nasdaq, more than last year's estimated daily average of 9.65 billion.

Declining stocks outnumbered advancing ones on the NYSE by a ratio of about 6 to 1, while on the Nasdaq, about 29 stocks fell for every five that rose.

Reuters

http://www.smh.com.au/business/markets/us-stocks-dive-as-greek-crisis-takes-toll-20100505-u7o3.html

Spanish stocks fall 5%

Spanish stocks fall 5%
May 5, 2010 - 7:54AM
AFP

The Spanish stock market plunged more than 5.0 per cent on Tuesday on investor fears the Greek debt crisis could spread to other eurozone countries - such as Spain - struggling to contain public deficits.

The benchmark Ibex-35 share index shed 5.41 per cent led by losses in banking stocks amid concern that Spain could be hit with fresh credit downgrades following a cut by Standard & Poor's last week.

The stock market was also hit by market rumours that Spain would ask for 280 billion euros ($A398.58 billion) in aid from the International Monetary Fund, which were dismissed by Spanish Prime Minister Jose Luis Rodriguez Zapatero as "absolute madness".

"These rumours are intolerable," he told a news conference in Brussels.

The head of the OECD meanwhile insisted that the situation in Greece was not comparable to that in Spain or another eurozone state seen as vulnerable, Portugal.

On Sunday, European nations endorsed an unprecedented 110-billion-euro ($A157.62 billion) bailout package to save Greece from bankruptcy and shore up the euro single currency.

Both the Moody's and Fitch agencies said Tuesday they were not reevaluating their rating for Spain, which is currently AAA, the highest possible rating.

"At the moment that I am speaking to you, the rating for Spain is still triple A, with a stable outlook," a Fitch spokeswoman told AFP in Paris.

S&P on Wednesday lowered Spain's long-term sovereign credit rating to AA from AA+ amid fears its recession could further weaken its public finances.

The move on Spain came one day after it cut Portugal's long-term credit rating by two notches and reduced Greece's rating the junk status, the first eurozone country rated less than investment grade since the launch of the euro.

Spain, which has the eurozone's third-largest deficit after Ireland and Greece, was last cut by S&P in January 2009 when its credit rating was lowered one notch from AAA.

Markets are especially sensitive to Spain's fiscal situation because of the size of its economy, which is Europe's fifth largest. European banks also have far greater exposure to Spanish debt than to Greek or Portuguese debt.

While Greece's public deficit was equal to 13.6 per cent of its gross domestic product (GDP) last year, in Spain it was 11.2 per cent.

Greece's debt-to-GDP ratio is 115.1 per cent, compared to just 53.2 per cent in Spain.

Spain will on Thursday issue five-year bonds with a proposed interest rate of 3.0 per cent that will expire on April 30, 2015. It hopes to raise at least two billion euros.

© 2010 AFP

http://news.smh.com.au/breaking-news-business/spanish-stocks-fall-5-20100505-u7t6.html

Why you should worry about Greece

Why you should worry about Greece
GREG HOFFMAN
May 3, 2010

A glance at a chart of the All Ordinaries index since its March 2009 low gives a fair indication that worrying is not currently on the agenda for most investors. ''Stocks are going up,'' they might observe of the 50 per cent rise, ''now's the time to buy.''

''Stocks have already gone up,'' we might reply at The Intelligent Investor. And as our former editor James Carlisle likes to remind people, stocks have no mass and therefore cannot have ''momentum'' in the scientific sense.

Small, regular gains can be easily stripped away by downward ''gaps'' in price; such as that experienced last week by investors in popular biotech stock Biota, which saw its stock fall sharply after investors were disappointed with the latest royalty payments relating to its anti-flu drug, Relenza.

It's important that we don't become complacent following a year of strong gains. And our team has many things on its worry list. One of those is a potential sovereign debt explosion. We saw wobbles in Dubai late last year and Greece is currently making plenty of headlines.

''The Greek debt crisis is now morphing into something much broader,'' wrote Mohamed El-Erian in the Financial Times recently.

El-Erian is chief executive and co-chief investment officer of Pimco, the world's largest bond investor. That alone would make his thoughts on the topic noteworthy. The fact that he is also a former deputy director of the International Monetary Fund (and was put forward as a potential managing director of the IMF in 2004) provides even more weight to his insights.

''Markets are now catching up to the reality of over-burdened public finances in the aftermath of the global financial crisis,'' El-Erian explained.

''These developments are of particular concern to countries with elevated debt levels and challenging maturity profiles for this debt. Indeed, absent some dramatic change in sentiment, they will need to worry not only about their ability to mobilise new funding from the private sector at reasonable cost, but also about keeping their existing creditors on board.''

He then stated his view of the likely next steps in this messy situation: ''As a result, credit downgrades will multiply. And once a package is approved for Greece, there will be questions as to whether similar packages can be secured for other vulnerable countries in the European Union.''

Eye-catching insight

Those comments are usefully succinct but not particularly out of the mainstream. What caught my eye in the same piece was the following insight:

''...the disorderly market moves of recent days will place even greater pressure on the balance sheets of Greek banks and their counterparties in Europe and elsewhere. The already material risks of disorderly bank deposit outflows and capital flights are increasing. The bottom line is simple yet consequential: the Greek debt crisis has morphed into something that is potentially more sinister for Europe and the global economy. What started out as a public finance issue is quickly turning into a banking problem too; and, what started out as a Greek issue has become a full-blown crisis for Europe.''

With substantial action from the European Union and the IMF, these ructions may prove a sideshow for Australian investors (as did last year's concerns about Dubai). But if El-Erian's fears prove well founded, we may be at the start of something much more serious.

The key point is that there are substantial risks in the global economy and it is foolish to ignore them. And, on a related note, over the past two years we've seen just how vulnerable our Aussie dollar can be to a loss of confidence.

Perhaps we're now firmly locked in to a Chinese ''growth miracle'' and our currency has found a new, permanently high plateau. But if that's not the case, now might prove an advantageous time to add some well-chosen international exposure to your portfolio.

This article contains general investment advice only (under AFSL 282288).
Greg Hoffman is research director of The Intelligent Investor

http://www.smh.com.au/business/why-you-should-worry-about-greece-20100503-u2s0.html

Wishing Greece Had Never Joined the Euro

Wishing Greece Had Never Joined the Euro
By DAN BILEFSKY
Published: May 4, 2010

ATHENS — It was a harbinger of things to come.

In April 1997, the Greek finance minister, Yannos Papantoniou, implored his European Union counterparts at a meeting in Brussels to print some of the future euro notes in Greek letters. But then a stern-faced Theodore Waigel, the German finance chief, weighed in.

Latin alphabet only, Mr. Waigel insisted. Besides, Mr. Papantoniou recalls Mr. Waigel saying, poor small Greece was in no position to make demands: “He said to me, ‘What makes you think you will ever be in the euro?”’

But Mr. Papantoniou, a Socialist who shepherded Greece’s entry into the euro zone, had the last word. “I replied that Greece would be in the euro and that a poor villager in Greece would never embrace the currency unless it looked Greek,” he said during an interview. “It was a matter of pride. I fought hard, and placed a bet with him then and there — and I won.”

Now, as Greece’s E.U. partners prepare to bail out the debt-ridden country — the first time that the 16-nation euro zone has needed to rescue one of its members — many critics, inside and outside the country, are wishing that Mr. Papantoniou had lost his bet.

Amid growing concern that the contagion could spread to countries along Europe’s southern tier and even infect the Continent’s banking system, Greece’s turbulent recent history suggests that the crisis is, in many ways, a peculiarly Greek tragedy. It is rooted in an ancient country’s epic profligacy and abetted by the hubris of European leaders whose desire for integration at any cost compelled them to allow political considerations to trump economic realities.

By many accounts, Europe’s current plight can be traced to 1981, when Greece, still emerging from the aftermath of a military dictatorship, rushed to join the European Community, 14 years ahead of the much-richer Austria, Finland and Sweden, and five years before Spain and Portugal.

At the time, President François Mitterrand of France opposed the bloc’s southward expansion, fearing that countries like Greece were not ready.

But those in favor of expansion carried the day, arguing that linking countries like Greece, Spain and Portugal to European structures was the best means to modernize their fragile democracies.

For the classically educated leaders of Europe, who viewed Greece as the cradle of democracy, tying the poor Balkan country to the geographically distant western Europe was, Mr. Papantoniou recalled, a “historic mission.”

During Greece’s first decade of membership, Europe’s generous subsidies helped catapult Greece out of its backwardness. By 1997, when European leaders prepared to inaugurate the single currency, some were praising Greece, which was enjoying steady economic growth of more than 3 percent under the Socialist government of Prime Minister Costas Simitis.

For Athens, Mr. Papantoniou recalled, joining the euro was a matter of pride and necessity in that it would stabilize the country’s economy by fending off predatory speculators while allowing Greece access to credit at low interest rates as part of the wealthy euro club.

“Once we were in line to join the euro, we started to transform from a Third World country to one that aspired to look more like Switzerland,” he said.

But Greece’s path to the euro was far from assured. Public opinion in Germany, scarred by the memory of wartime hyperinflation, was wary of giving up the Deutsch mark, and the German government insisted on tough conditions for those countries wanting to join. 

• Budget deficits were supposed to be less than 3 percent of gross domestic product, 
• debt was not to exceed 60 percent of G.D.P. and 
• inflation could not top 3 percent.

In December 1996, the currency’s rules were toughened in a so-called Stability and Growth Pact, intended to fine members that persistently failed to conform. The unspoken intention was to raise the barrier for southern European countries, which were seen as having looser, more inflationary, economic policies.

Germany wanted the fines to be automatic, but other countries, led by France, put the onus of enforcement on E.U. political leaders. (No country, Greece included, has ever been fined even though the rules have been routinely broken by most countries in the euro zone.)

The euro was fundamentally a political creation, which meant that the rules could be bent when deciding whom to admit. So, the 11 countries that locked their currencies in January 1999 — the first stage in the creation of the euro — included Italy, Belgium, Spain and Portugal. Greece failed to join because of budgetary and inflationary woes.

The European Central Bank expressed concern about Greek finances as early as 2000, noting in a report that Greece’s total debt was far above the prescribed limit.

Still, Athens kept up the pressure to be admitted in time for the debut of euro notes and coins in 2002. Mr. Simitis, who had taught at a German university in the 1970s, adroitly lobbied German politicians and bankers, mindful of their resistance.

In the end, Greece joined a year earlier than expected, in January 2001. It had — on paper — sharply reduced its budget deficit. And, while it had not reduced debt sufficiently, it invoked the precedents of other countries, like Italy and Belgium, which had been allowed in despite breaching the limit. The political imperative of keeping the euro on track silenced critics.

“At the time there were clear indications that the Greeks were forging the data, especially data on deficits to make their public finance situation look more benign than it really was,” said Jürgen von Hagen, professor of economics at the University of Bonn. “But European governments did not want to pay attention. For political reasons they wanted Greece in.”

The laxity with regard to fiscal discipline extended to the biggest players in the euro club. In 2002, 2003 and 2004 even Germany and France breached the deficit rules, setting a dangerous precedent.

By 2004, it was clear that Greek economic data was faulty. The Union opened its first investigation into Greece’s deficit. But despite evidence compiled by Eurostat, the Union’s official statistics agency, that Athens had fudged the numbers, Union officials made clear that ejecting Greece from the euro zone was not an option.

Mr. Papantoniou, the former finance minister, blamed the discrepancy in the deficit figures on a change of accounting rules under the center-right government of Kostas Karamanlis, who came to power after the Socialists were ousted in March 2004 and altered the way military spending had been calculated.

“It’s a big lie that the Greeks falsified the statistics,” Mr. Papantoniou said.

Tommaso Padoa-Schioppa, a former executive board member of the E.C.B., recalled that after questions arose about the accuracy of Greek financial data, many countries shot down attempts to strengthen Eurostat’s oversight powers

“The fact is that an opportunity was lost at the time,” he said. “Greece is to blame for its poor management of public finance and competitiveness. But the peers have to be blamed for not doing their job sufficiently well.”

But even apart from the statistics debacle, Greece’s economy soon lurched from bad to worse. Mr. Karamanlis went on a spending spree to prepare for the 2004 Summer Olympics; the increased security costs imposed after the September 11 terrorist attacks in 2001 pushed the price tag even higher.

More broadly, said Yiannis Stournaras, a leading economist and former advisor to the ruling Socialist Party, Greece treated entry into the euro as an invitation to party.

“Instead of cutting the deficit and liberalizing the economy,” he said, “the country continued to spend.”

Governments on the left and the right failed to overhaul a bloated public sector that critics have compared with a Soviet-style system.

“Now we are paying the price for the fact that we lived above our means, with amazing profligacy, and failed to reduce the role of the state,” Mr. Papantoniou said. “Some might say we should have done more.”


Additional reporting was contributed by Stelios Bouras in Athens, Stephen Castle in Brussels and Jack Ewing in Frankfurt.

http://www.nytimes.com/2010/05/05/business/global/05iht-greece.html?ref=business

Stocks in tailspin on global debt fears

April 28, 2010

‘‘It can really be summed up in one word -- contagion,’’ said CMC Markets analyst Michael Hewson.

The markets fell after Standard & Poor’s, a leading international ratings agency, downgraded Greek sovereign debt to junk status and cut Portugal’s long-term credit score by two notches.

The London stock market dived 2.61 per cent, the Frankfurt DAX sank 2.73 per cent and the CAC 40 in Paris plunged by 3.82 per cent.

The Lisbon stock market sank by 5.36 per cent and Athens plunged 6 per cent.

Wall Street was also sharply lower, with the Dow Jones industrial shedding 213.04 points, or 1.9 per cent, to close at 10,991.99. The Standard & Poor's 500 Index lost 28.34 points, or 2.34 per cent, to finish at 1183.71. The Nasdaq Composite Index fell 51.48 points, or 2.04 per cent, to wind up at at 2471.47.

Austock Securities senior client adviser and strategist Michael Heffernan said the lead from Wall Street and Europe was driving the losses, but Europe’s sovereign debt issues had minimal impact on Australian shares.

‘‘Its totally unsurprising we’re down given the lead from overseas,’’ he said.

‘‘The debt issues have absolutely zero effect here, frankly.

‘‘These ratings agencies are about six months behind the curve... so the fact that markets go down simply because credit ratings agencies have downgraded Greece and Portugal’s ratings is absolutely no reason at all why our banks and major resources should be down.’’

Wilson HTM head of private wealth management Derek Growns said that the jitters flowing out of Europe aren’t surprising because they’ve been coming for a while.

The issues surrounding sovereign debt will ultimately be sorted out in Europe. ‘‘But the countries involved - particularly Greek residents - are going to have to face up to the fact they have to cut spending and raise taxes.’’

http://www.brisbanetimes.com.au/business/markets/australian-stocks-in-tailspin-on-global-debt-fears-20100428-tqaj.html

Eurozone could risk 'sovereign debt explosion'

Europe's governments are at increasing risk of an interest rate shock this year as the lingering effects of the Great Recession drive debt issuance to record levels and saturate bond markets, according to Standard & Poor's.

By Ambrose Evans-Pritchard, International Business Editor
Published: 6:30AM GMT 12 Mar 2010

Comments 23 | Comment on this article

Italy has to refinance 20pc of its entire debt, tapping the bond markets for a total ?259bn this year

"Debt-related sovereign vulnerabilities have increased, particularly in the Eurozone, where we expect government borrowing will rise to further new peaks," said Kai Stukenbrock, the ratings agency's European credit analyst. "The resulting fiscal pressure from a sustained increase in financing cost could be significant in our view."

The warning comes as bond giant PIMCO spoke of a "sovereign debt explosion" that has taken the world into uncharted waters and poses a major threat to economic stability. "Our sense is that the importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood," said Mohamed El-Erian, the group's chief executive.

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Mr El-Erian said most analysts are still using "backward-looking models" that fail to grasp the full magnitude of what has taken place in world affairs since the crisis. Some 40pc of the global economy is in countries where governments are running deficits above 10pc of GDP, with no easy way out.

Standard & Poor's said Europe's states need to raise €1,446bn (£1,313bn) this year as the full damage inflicted by the credit collapse – masked last year by emergency stimulus measures – becomes ever clearer. This will become harder to fund cheaply as central banks start to tighten. "We believe that benchmark yields have benefited from liquidity injections into the financial sector and quantitative easing measures by the Bank of England and the Federal Reserve. As that support could eventually be withdrawn from 2010, excess supply in government bond markets could start driving benchmark yields back up. Such a development could add to fiscal pressure in a number of sovereigns with high deficits," it said.

Several states have come to rely on cheap short-term funding, storing up "roll-over risk" that will come to a head in coming months. Italy has to refinance 20pc of its entire debt – the world's third largest after Japan and the US – tapping the bond markets for a total €259bn this year. Belgium has to roll over 22pc of its substantial debt.

"This implies dependence on more or less constant access to financial markets," said the report.

Weaker states risk a double effect of rising yields on benchmark bonds as well as higher spreads as investors demand a greater risk premium in the harsher climate now facing heavily-indebted countries.

Greece has already seen a surge of 300 basis points in its long-term funding costs since the new Pasok government of George Papandreou revealed that the country's true budget deficit was 12.7pc, double the previous estimate.

The agency estimates that a sustained rise in yields of 300 basis points would raise the burden of interest costs each year by 3.9pc of GDP for Greece, 2.6pc for Portugal, and 2.5pc for Italy and Britain by the middle of the decade.

A jump of this kind would amount to an extra £35bn or so in annual interest costs, roughly equal to the UK defence budget. This would play havoc with UK public finances and force the Government to squeeze fiscal policy even further. S&P's warning clearly underscores the risk of waiting too long before restoring the deficit to a sustainable path.

The report said there had been a notable increase in "alternative channels of borrowing" that "embellish" the true debt picture. France's Société de Financement de l'Economie (SFEF) has issued €77bn of state-backed bonds since 2008 and the Caisse d'Amortissement de la Dette Sociale has amassed liabilities of €103bn. Austria's infrastructure financing companies, used to buttress state stimulus programmes, have €23bn in debts.

This hidden iceberg of debt kept off balance sheet is likely to be the next focus of bond vigilantes.


http://www.telegraph.co.uk/finance/economics/7424555/Eurozone-could-risk-sovereign-debt-explosion.html

Greek crisis: the eurozone in numbers

As the eurozone grapples with its worst internal economic tensions since its birth 11 years ago, we chart the areas market movements and macroeconomic trends.
1) Eurozone debt shares and spreads over German bonds.

http://www.telegraph.co.uk/finance/economics/7206100/Greek-crisis-the-eurozone-in-numbers.html

Greek crisis: Q&A

Greek crisis: Q&A
As EU leaders meet in Brussels today to find a solution to Greece's debt crisis, here's an explanation of the problems facing them.


Published: 7:34AM GMT 11 Feb 2010

Q How much scope does the European Union have to help Greece?

A It's complicated. The EU is bound by its own treaty, which has no clear procedure for bailing out a eurozone economy. The EU should be able to come up with a legal justification but the process could be time-consuming and complex and none of the potential options will be popular with member states not in crisis. It may need to use a variety of available options.

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Q Can't the EU just lend Greece the money it needs?

A Things are not that easy. EU law says the union "shall not be liable for or assume the commitments of central governments" unless in the joint execution of a specific project. Attention has turned to Article 122 of the EU treaty which lets the EU help a member state threatened by "exceptional circumstances beyond its control". Greece's poor fiscal record makes it difficult to argue this case, but blaming international speculators could provide cover for such a move.

Other routes could include defining aid as coming from individual member states or for EU governments to buy Greek bonds and justify this action by telling taxpayers the purchase is an investment, not a bail-out.

Q What are the other options available to the EU?

A Greece is waiting on €18.1bn (£16bn) of structural funds earmarked under the 2007-2013 EU budget. The European Commission could decide to pay these funds early, as it did with €7bn for central and eastern European members last year.
The European Investment Bank, which is owned by EU governments, could borrow money in the market relatively cheaply to buy Greek bonds, though this option would probably need agreement from EU finance ministers. The EU might also issue common bonds with Greece taking a share of the proceeds, lowering its borrowing costs. However, the idea of EU common bonds has received little support in the past.

Q Isn't this what the International Monetary Fund is for?

A The IMF is already advising Greece on how to handle its fiscal crisis but requesting IMF financial support for Greece would be unpopular among other European states and a huge embarrassment to the EU.

IMF assistance could come in the form of precautionary funding, possibly including EU support, for Greece to tap if necessary to soothe market nerves. The IMF might also make available its Flexible Credit Line, which was set up for emerging markets to tap during the crisis. However, Greece's poor record would probably bar it from using this fund, which is intended for economies with strong fundamentals facing short-term problems.

The EU is more likely to ask the IMF to monitor and report on Greece's performance against its promises to provide reassurance for investors.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/7207492/Greek-crisis-QandA.html

Eurozone 'pigs' are leading us all to slaughter

Eurozone 'pigs' are leading us all to slaughter
The financial crisis is coming to a new, potentially more deadly phase, says Jeremy Warner.


By Jeremy Warner
Published: 7:17PM GMT 05 Feb 2010

The 'pigs' of the Eurozone are causing worries for the other members Photo: AFP/Getty Images

Are we about to enter a third, and this time fatal, leg of the financial crisis? The problems of euroland which have so unsettled markets this week – and in particular those of Portugal, Ireland, Greece and Spain (the "pigs", as they have become known in financial circles) – are worrying enough in themselves.

But they are also a proxy for much wider concern about how national governments extract themselves from the fiscal and monetary mire they have created in fighting the downturn. It's proving messy, though, and they are running the risk of provoking an even worse crisis in the process.


Think of the three phases of the economic implosion like this.

1.  The first was a fairly conventional, if extreme, banking crisis where a cyclical overexpansion of credit and lending suddenly, and violently, corrects itself in a great outpouring of risk aversion.

2.  In the second phase, governments and central banks attempt to counter the economic consequences of this crunch with unprecedented levels of fiscal and monetary support. Temporarily, at least, it seemed to work.

Until now, investors have been happy to finance the resulting deficits, in part because government bonds have seemed the only safe place to put your funds, but also because central banks have, in effect, been creating money to compensate for the paucity of private-sector credit. The mechanism varies from region to region, but much of this new money has found its way into deficit financing.

3.  We are now entering the third, inevitable phase of the crisis where markets question the ability of even sovereign nations to repay their debts. Unnerved by this loss of fiscal and monetary credibility, governments and central banks are being forced, much sooner than they would have wished, to start withdrawing their support.

I say earlier than they would have wished because the recovery is not yet assured. Private demand and credit provision remain subdued. Policy-makers knew they would eventually have to abandon their fiscal and monetary support, but the timing of it may no longer be a matter of choice.

The first tremors around these so-called "exit strategies" occurred in Dubai a few months back when the emirate, fearing for its own solvency, shocked markets by announcing that it no longer stood behind the debts of its financially stretched state-owned enterprises. In this case, Dubai's fellow and richer emirate, Abu Dhabi, eventually came to the rescue.

It is much less clear that Greece, Spain, Portugal and Ireland can rely on similar support, either from richer members of the euro area or the European Central Bank.

For the "pigs", membership of the euro excludes the easy option, which is to devalue and turn on the printing presses according to local needs. Instead, monetary policy, and increasingly fiscal policy too, are dictated by Germany and France, the core euro nations.

Whether the fiscal consolidation demanded is politically feasible looks questionable. And even if these countries do succeed in making the necessary adjustments, they may face a classic deflationary debt spiral, where slashing the deficit causes the economy to shrink further which, in turn, increases the deficit.

Little surprise, then, that one of the big bets in markets right now is that these distressed members of the euro will be forced either into default, or rather like Britain with the ERM in the early 1990s, out of the single currency altogether. Serious knock-on consequences for creditor economies would follow.

Yet to true believers in the doomsday scenario, even an outcome as extreme as this would not be the end of the crisis. Fiscal ruin is not confined to the southern European nations. The hors d'oeuvre consumed, it would be on to the main course – the default of one or more of the big, triple-A rated sovereigns. Financial and economic chaos would follow quickly in its wake.

There's a world of worry out there, fed by self-interested speculators, which is proving hard to counter. Yet things rarely work out as predicted, and though nobody should be in any doubt about the scale of the economic adjustment still to be made in Western economies, more benign outcomes are still possible. Bigger, advanced economies with their own currencies are better placed to manage their exits than the "pigs".

However, right now, both Washington and London seem gripped by the sort of political paralysis that can indeed prove lethal. We should not assume that the sudden loss of market confidence that has afflicted Greece – essentially a developing market economy that should never have been in the euro in the first place – will be confined to the "pigs". The burgeoning size of public indebtedness the world over makes all economies vulnerable.

Even so, this week's tremors should be seen as more of a warning than the beginning of a fatal endgame. The austerity of tighter fiscal and monetary conditions is coming to all of us. With or without the compliance of policy-makers, the markets will impose it. But it doesn't have to be a rout.

http://www.telegraph.co.uk/finance/comment/jeremy-warner/7168631/Eurozone-pigs-are-leading-us-all-to-slaughter.html

Global stock market shakeout spreads to Asia

Global stock market shakeout spreads to Asia
Asian stocks tumbled on Friday after Wall Street dropped overnight on worries the global recovery is weaker than many expected.



Major markets from Tokyo to Hong Kong to Sydney dropped about 3pc or more after US stocks fell on bad news about American unemployment levels and European debt.

Oil prices slipped to near $73 a barrel, adding to a big slide overnight, while the dollar continued to gain against the euro, which was at its lowest since May.

Japan's benchmark Nikkei 225 lost 2.8pc, or 293.33 points, to 10,062.65 and China's Shanghai Composite Index fell 1.6pc, or 50.85, to 2,945.13. Hong Kong's Hang Seng was down 3.2pc at 19,701.33.

In the US on Thursday, the Dow Jones industrial average closed down 268.37, or 2.6pc, at 10,002.18 after briefly trading below 10,000 for the first time in three months. That came after the Labor Department said claims for unemployment benefits rose by 8,000 to 480,000 last week, disappointing investors who hoped for a decrease.

The slide began in Europe, where markets were dragged down by concern about high debt levels in Greece, Spain and Portugal. It is becoming harder for countries to contain rising debts and to borrow money to spend their way out of recession. Spain's IBEX tumbled 5.9pc, London's FTSE 100 2.2pc, Germany's CAC 2.5pc, and France's CAC 2.7pc.

Elsewhere in Asia, South Korea's Kospi was off 3pc at 1,568.33 and Taiwan's Taiex dived 3.3pc. Sydney's S&P-ASX 200 slid 2.8pc.

http://www.telegraph.co.uk/finance/markets/7162843/Global-stock-market-shakeout-spreads-to-Asia.html

Greece crisis: There but for the grace of God goes Britain

Greece crisis: There but for the grace of God goes Britain

Should markets pass the same verdict on Britain as on Greece, the results would be almost identical - and just as disastrous, says Edmund Conway.


By Edmund Conway
Published: 6:47AM GMT 04 Feb 2010



It was one of those moments that can only happen in a place like Davos. There I was last week, having a coffee and minding my own business, when from a nearby table I heard a desperate voice. I assumed it belonged to a beleaguered bank executive, or a stricken hedge fund manager. “We are doing everything we can,” he said, “but the markets don’t care.”

I looked up and realised the voice belonged to the Greek prime minister. His arms crossed defensively, George Papandreou was now listening as one of the world’s top economists told him he thought his best bet was to seek an emergency bail-out from the International Monetary Fund.

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A recession for the many, not the few

Greece is indeed buried deep in the financial mire. At first gradually, and then with alarming speed, the country has lost credibility with investors to such a degree that it is now having to offer an interest rate of 7 per cent to persuade them to buy its debt, compared with 4.5 per cent a few months ago.

Some, including Papandreou, characterise this as a speculative move aimed at splitting up the euro; others see it as a statement of economic disgust at a country whose public finances, always bad, have now dipped into no-hope territory.

There is some truth to both theories, but, more important, at least for both Gordon Brown and David Cameron, there is a broader lesson: the only thing that matters more than knowing what to do about the deficit is persuading the markets that you know what you’re doing about the deficit. Because there but for the grace of God goes Britain. There is no knowing how and when investors will lose their faith in a government, but when it’s gone, there isn’t much you can do to get it back.

Greece, in other words, is the fiscal Petri dish that reveals in gory detail what could happen in the UK if this Government – or the next – fails to maintain the confidence of investors. It is not merely that those interest rates are already inflicting an awful toll on borrowers in Athens and beyond. It is that they are sending the national government towards a full-blown debt spiral, in which the cost of its annual interest bill becomes so unmanageable that it can hardly afford to supply its citizens with basic services.

I have pointed out before that countries, like individuals, occasionally reach the point where they have borrowed so much that their debt simply becomes impossible to whittle away. Greece, the markets seem to think, has now passed that point. And an IMF bail-out would only layer new debt on top of the old. In the end, the only solution is to find some way to slash spending and raise taxes without a) sparking riots or revolution and b) critically damaging the economy.

Should markets pass the same verdict on Britain as on Greece, the results would be almost identical. In its Green Budget yesterday, the Institute for Fiscal Studies, with the help of Barclays Bank, attempted to map out what would happen if the Government failed to achieve the necessary cuts in its budget in the coming years. The verdict: a “very large, and fast-acting” impact on interest rates, pushing them even higher than Greek rates today.

Still, we are not there yet. And there are four reasons to be cautiously optimistic about Britain’s chances. The first is that much of the population is already reconciled to some form of austerity. Both main parties want to cut the deficit sharply, and although the Tories talk a little tougher, in economic terms there is actually not that much clear water between their proposals and those already laid out by the Treasury.

Second, the UK started the crisis with national debt below 40 per cent of gross domestic product, compared with Greece, whose national debt was already close to the 100 per cent of GDP – near the tipping point for a debt spiral. Third, it is a little-appreciated quirk of the British market that, rather like a homeowner on a long fixed-rate mortgage, the Government has to roll over its debt far less regularly than other countries, so is significantly insulated from a Greek-style crisis.

And fourth, unlike Greece, Britain has its own currency, which affords it more leeway to adjust.

But as Greece has shown, a credibility collapse can take place even when you least expect it. Despite George Osborne’s pledge earlier this week to safeguard Britain’s credit rating, some still reckon there is an 80 per cent chance of the UK losing its coveted triple-A status – something that could trigger an investor panic.

So both main political parties should, as a matter of course, prepare detailed emergency plans saying what overnight cuts they would impose in the event of a similar crisis.

However, avoiding such a credibility collapse will not spare Britain from having to drag itself through an economic transformation with the same end: to reduce debt and to live within its means. For some countries, the financial crisis was painful because people suddenly started spending less. For Britain, it uncovered the fact that the nation had duped itself into believing it was more prosperous than it really was. We mistook a debt bubble and the proceeds of financial engineering for sustained and lasting growth. Time to get real. 

http://www.telegraph.co.uk/finance/comment/edmundconway/7153169/Greece-crisis-There-but-for-the-grace-of-God-goes-Britain.html

Fears of 'Lehman-style' tsunami as crisis hits Spain and Portugal

Fears of 'Lehman-style' tsunami as crisis hits Spain and Portugal

The Greek debt crisis has spread to Spain and Portugal in a dangerous escalation as global markets test whether Europe is willing to shore up monetary union with muscle rather than mere words.


By Ambrose Evans-Pritchard
Published: 7:29PM GMT 04 Feb 2010


Julian Callow from Barclays Capital said the EU may to need to invoke emergency treaty powers under Article 122 to halt the contagion, issuing an EU guarantee for Greek debt. “If not contained, this could result in a `Lehman-style’ tsunami spreading across much of the EU.”

Credit default swaps (CDS) measuring bankruptcy risk on Portuguese debt surged 28 basis points on Thursday to a record 222 on reports that Jose Socrates was about to resign as prime minister after failing to secure enough votes in parliament to carry out austerity measures.

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Parliament minister Jorge Lacao said the political dispute has raised fears that the country is no longer governable. “What is at stake is the credibility of the Portuguese state,” he said.

Portugal has been in political crisis since the Maoist-Trotskyist Bloco won 10pc of the vote last year. This is rapidly turning into a market crisis as well as investors digest a revised budget deficit of 9.3pc of GDP for 2009, much higher than thought. A €500m debt auction failed on Wednesday. The yield spread on 10-year Portuguese bonds has risen to 155 basis points over German bunds.

Daniel Gross from the Centre for European Policy Studies said Portgual and Greece need to cut consumption by 10pc to clean house, but such draconian measures risk street protests. “This is what is making the markets so nervous,” he said.

In Spain, default insurance surged 16 basis points after Nobel economist Paul Krugman said that “the biggest trouble spot isn’t Greece, it’s Spain”. He blamed EMU’s one-size-fits-all monetary system, which has left the country with no defence against an adverse shock. The Madrid’s IBEX index fell 6pc.

Finance minister Elena Salgado said Professor Krugman did not “understand” the eurozone, but reserved her full wrath for the EU economics commissioner, Joaquin Almunia, who helped trigger the panic flight from Iberian debt by blurting out that Spain and Portugal were in much the same mess as Greece.

Mrs Salgado called the comparison simplistic and imprudent. “In Spain we have time for measures to overcome the crisis,” she said. It is precisely this assumption that is now in doubt. The budget deficit exploded to 11.4pc last year, yet the economy is still contracting.

Jacques Cailloux, Europe economist at RBS, said markets want the EU to spell out exactly how it is going to shore up Club Med states. “They are working on a different time-horizon from the EU. They don’t think words are enough: they want action now. They are basically testing the solidarity of monetary union. That is why contagion risk is growing,” he said.

“In my view they underestimate the political cohesion of the EMU Project. What the Commission did this week in calling for surveillance of Greece has never been done before,” he said.

Mr Callow of Barclays said EU leaders will come to the rescue in the end, but Germany has yet to blink in this game of “brinkmanship”. The core issue is that EMU’s credit bubble has left southern Europe with huge foreign liabilities: Spain at 91pc of GDP (€950bn); Portugal 108pc (€177bn). This compares with 87pc for Greece (€208bn). By this gauge, Iberian imbalances are worse than those of Greece, and the sums are far greater. The danger is that foreign creditors will cut off funding, setting off an internal EMU version of the Asian financial crisis in 1998.

Jean-Claude Trichet, head of the European Central Bank, gave no hint yesterday that Frankfurt will bend to help these countries, either through loans or a more subtle form of bail-out through looser monetary policy or lax rules on collateral. The ultra-hawkish ECB has instead let the M3 money supply contract over recent months.

Mr Trichet said euro members drew down their benefits in advance -- "ex ante" -- when they joined EMU and enjoyed "very easy financing" for their current account deficits. They cannot expect "ex post" help if they get into trouble later. These are the rules of the club.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/7159456/Fears-of-Lehman-style-tsunami-as-crisis-hits-Spain-and-Portugal.html

Acronym: PIGS = Portugal, Ireland, Greece and Spain