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Economic Reality: Nowhere to Run, Nowhere to Hide, Part 2

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The onset of the Global Sovereign Crisis marks a new dangerous phase of the credit crisis.

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The most important consequence of Greece and European sovereign debt problems will be to force governments everywhere to stabilize and reverse the deterioration in public finances by a combination of new taxes and cutting expenditures. Many indebted economies, including Britain and Italy, have implement austerity measures. The sharp reduction of government spending coincides with the end of the effects of stimulus packages and is likely to slow economic growth.

Country-specific factors -- attempts by China to rein in excessive lending growth and property price rises; higher interest rates in Australian and India, driven by perceived inflation in local economies -- may also undermine growth. Government demand for funds and deteriorating conditions in the financial system will reduce the availability of funds and increase cost, further restricting growth.

The GSC has profoundly shifted economic dynamics. Refusing to acknowledge the real problems, major economies have, over the last decades, transferred debt from companies to consumers and finally onto public balance sheets. A huge amount of assets and risk are now held by central banks and governments, which aren't designed for such long-term ownership. There are now no more balance sheets that can be leveraged to support the current levels of debt.

Borrowing can only be repaid by the sale of assets, including those funded by the debt, or by redirecting income, perhaps generated by the asset purchased, toward repayments. Unfortunately, in many cases, the current value of the asset won't cover the outstanding debt. The level of income and cash flow generated is insufficient to cover interest costs or amortize the amount borrowed. The GSC focused attention on the excessive level of debt and how it was used.

Based on per capital income of $30,000 (roughly 75% of Germany), Greece gives the appearance of a developed economy. In fact, Greece's economy and its institutional infrastructure are weak. In the World Bank's Index for Doing Business that measures the commercial environment, Greece ranks 109th behind Lebanon, Egypt, and Ethiopia and, among developed countries, in the same index, second-last. Around 30% of the Greek economy is unreported and informal. Tax-revenue losses may be around $30 billion per annum. Productivity and quality are low. Despite the size of the public sector, public services are inadequate. Corruption is endemic.

While entry into the euro may have assisted Greece's ascension into major-league status, the euro decreased international competitiveness as the country effectively priced itself out of the market for goods and services. Entry into the euro compounded existing weaknesses by providing access to low-cost funds. Greek bonds became eligible as collateral for ECB funding. Assumptions of "implicit" ECB and EU support (since proven correct) facilitated easy access to bank funding. A period of credit-driven expansion financed a construction boom and social policies, such as early retirement with large pension entitlement, often in excess of those available in more affluent countries.
No positions in stocks mentioned.

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