Despite the fact that Greece is in Europe (not here in the US) and has a very small economy, it matters a great deal what happens there in the coming days, weeks, and months (March, April, May). This is because there will likely be a common / repeated theme in how Europe manages Greece with how they manage the rest of the PIIGS (aka PIGIS). Taken as a whole, the PIIGS are large enough to tank the European economy and -most importantly- cause an international bank solvency crisis resembling September 2008. 

So, the update…. Having been told (by the ECB / EU) that the planned 1% of GDP spending cuts, and 1% tax increases previously announced were not sufficient to write the Greek ship, Greece announced on Wednesday March 3rd they are almost doubling their planned 2010 tax increases and spending cuts.

Greece claims this will allow them to cut the 2010 budget deficit from 12.7% to 8.6%. The EU (especially Germany) remains unimpressed, for these reasons:

• Greece is likely looking at very nearly 13% deficit going into 2010, not 12.7%.
• The EU would like to see Greece cut the 2010 deficit closer to 8%.
• increasing taxes will not likely yield as much savings as claimed (it never does). Even more so in Greece where such a large portion of the economy is black market. There is a legitimate concern that raising taxes will just drive more of the economy underground.
• Greece will likely have a hard time achieving a 9% budget deficit in 2010 even with these newly announced measures. 9% is a far cry from 3% – where Greece and everyone else is supposed to be by 2012.

You really have to like the brashness of Greece’s Prime Minister. He is quoted as saying “We are now justifiably expecting EU solidarity.” Justifiably Expecting ? Greece is a sovereign nation that has been playing games with its finances for years and benefited unjustifiably since joining the monetary union. I don’t know how Mr Panandreou can rationalize his position of expecting other countries to bail it out.

Papandreou is asking the EU to continue to buy Greek bonds so that Greece won’t have to pay a rate of interest commensurate with the risk of default it represents. Rightfully, the Germans are balking at this. The Greeks are now making noise about the high rate of interest they had to offer in order to sell their bonds this week. Greece wants other sovereign governments in Europe to guarantee its debt so they won’t have to pay such high interest rates.

Germany and the rest of the EU’s central banks may end up buying Greek bonds in the short term, but not to the extent Greece wants. This will result in sustained higher interest rates paid by Greece as a punitive measure. I have my doubts that we’ll see a failed Greek sovereign bond auction until the big auctions happen in April & May ($31B needs to be rolled-over /sold then). April 20th is the next debt payment date.

This makes for very volatile markets. The upside is maybe 5-10% in equity markets for the core eurozone in 2010 from here. The downside is probably 15-40% from here if Greece defaults and initiates contagion. Even if everything goes well – because Europe provides support for Greece – we’re looking at years of economic stagnation while the PIIGS get their economic house in order. Germany -and the rest of Europe – needs those markets to export goods & services. Of course a sudden devaluation of the Euro -to par with the USD- would be tremendously beneficial for Europe (but not us).

Does this impact how we invest. Well, yes…. But you’ll need to be a client to get the recommendations.