by Pater Tenebrarum
Seeking Alpha
March 10, 2011
The Plight of Greece
It was easy in recent months to keep concerns over the euro area peripherals on the back burner. After all, the euro itself has been quite strong, lately in anticipation of ECB rate hikes. There is also a fundamental reason for euro strength that has been less obvious, but is no less real: money supply growth in the euro area has slowed down sharply.
Also, the excitement in the U.S. stock market and various commodity markets due to the Fed's ample supply of liquidity via QE2 has taken precedence over virtually all lingering concerns, regardless of their source.
It may be time to slowly but surely reconsider this stance. While market-based implied default probabilities have become less pronounced except in the case of Greece and Portugal, European bond yields have at the same time climbed to fresh highs across the board. There is no sign as of yet of this trend ending. To be sure, even Germany's yields have increased markedly, as inflation expectations have risen. However, not one of the peripherals has seen a reduction in yield spreads over German debt – instead new highs in these spreads have been posted in several cases.
It is now widely accepted lore that Greece no longer matters – after all, it represents only a small percentage (about 2%) of the euro area's economic output – and it has been bailed out. We continue to think that this complacency is misplaced. All indications are that the markets no longer believe it is possible for Greece to attain its deficit reduction targets or manage to return to a fiscal condition that will allow it avoid a debt restructuring. It costs now $1.34 million per year to insure $10 million in Greek debt for 5 years - a new record high. This implies very little by recovery on the part of current debt holders.
It is of course possible for markets to be mistaken in their assessment, but this is a case where we think it would be wise to heed their warning. Even if one believes that things will somehow get better, one should consider all possible outcomes. So the question is: what would happen if Greece were actually forced to restructure its debt?
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