Four Moves to Make Before Greece Defaults

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The very austerity measures that Greece implemented to remedy its sovereign debt crisis have crippled its economy so badly the country is actually sinking deeper into the red, making default all but inevitable.

Already suffering from a four-year-old recession, the Greek economy has been dragged down further by the series of austerity measures – tax increases combined with cuts in pensions and wages. As a result, the Greek economy is expected to contract 5.5% this year and 2.5% in 2012.

The Greek government announced this week that unemployment soared to 16.5% in July, up from 12% a year earlier. It's expected to rise to 17.5% before the end of this year.

With its gross domestic product (GDP) shrinking, Greece has less money to repay its debts, and worse, it must continue borrowing at higher interest rates.

Greece's debt-to-GDP ratio is expected to rise to 162% this year and 181% in 2012.

"Without drastic action, [Greece's] debt-to-GDP ratio will rise to even more alarming levels," a Milken Institute report on the Greek debt crisis said earlier this month. "The ratio is reaching levels at which it becomes extremely difficult, if not impossible, for a country to avoid default on its debt."

Even the "troika" of Greek lenders – the European Commission (EC), the International Monetary Fund (IMF) and the European Central Bank (ECB) – concluded in a report released yesterday (Thursday) that the troubled country's "debt dynamics remain extremely worrying."

"When compared with the outlook of a few months ago, the debt sustainability has effectively deteriorated given the delays in the recovery, in fiscal consolidation and in the privatization plan," the report said.

The report also expressed concern that Greece's budget deficit for 2011 will fall between 8.5% and 9% of GDP, which exceeds the target of 7.75% of GDP set by the troika as a condition for granting the most recent batch of bailout loans.

What's Next

To continue to meet the troika's criteria for still more bailout loans – which Greece must have to avoid default – even more austerity measures will be needed.

But the Greek public, as well as many politicians, has displayed more resistance with each new set of austerity measures.

Protests, strikes and riots have accompanied each new collection of austerity measures, growing larger and more severe each time. This week, a 48-hour strike has virtually shut the country down, and demonstrations in Athens turned violent.

Although the ruling Socialist Party is expected to have the votes to pass the latest austerity package this week, Greek lawmakers are tired of squeezing their citizens and are near the end of their rope.

Greek ruling party lawmaker Vasso Papandreou, who had threatened to vote against a piece of the law that suspends the power of unions, said yesterday she would support all of the measures "but this is the last time."

Another Lehman Meltdown

With the Greek debt crisis spiraling towards default, investors need to know how it could affect the markets in the United States – and what they can do to shield themselves from the disaster.

According toMoney MorningCapital Wave Strategist Shah Gilani, "U.S. banks are widely believed to have $41 billion of direct exposure to Greece" and have loaned heavily to their European counterparts.

More sobering, Gilani says, is that "U.S. money-market funds have a hefty European exposure, too." He noted that 12% of the loans made by our biggest money-market funds were made to three big European banks – two of which, Societe Generale SA (PINK ADR: SCGLY) and Credit Agricole SA, were downgraded by Moody's Corp. (NYSE: MCO) just last month.

The third, BNP Paribas SA, was downgraded by Standard & Poor's last week.

Meanwhile, Money Morning Chief Investment Strategist Keith Fitz-Gerald is gravely concerned about the how such downgrades will affect financial institutions deeply entrenched in the $600 trillion derivatives market.

Just four banks hold 95.9% of the derivatives in America, Fitz-Gerald said: JPMorgan Chase & Co. (NYSE:JPM), Citigroup Inc. (NYSE: C), Bank of America Corp. (NYSE: BAC) and Goldman Sachs Group Inc. (NYSE: GS).

"The firms trading in derivatives will have to come up with huge amounts of cash they don't have," Fitz-Gerald said. "So they will sell everything but the kitchen sink as a means of raising it."

A similar situation surrounding the demise of Lehman Bros. triggered the market collapse in 2008-2009.

Protect Yourself

Fitz-Gerald advises that investors do the following to guard their portfolios against the fallout from the Greek debt crisis:

  1. Sell into strength using trailing stops.That way you can capture the rally if it resumes and move your money to the sidelines if it doesn't. Nobody knows how long the fairy tale will last so you might as well let the markets show you the way instead of trying to second guess them and risk being wrong.
  2. Buy commodities.Holding energy and agricultural commodities as well as precious metals like gold and silver will help you preserve your wealth. Even after large pullbacks that may result from capital raising activities, the long-term direction for these is up. To minimize risks, buy in chunks or dollar cost average in over several months.
  3. Go Global.Put new money to work in "glocal" stocks. These are companies with fortress-like balance sheets, globally diversified revenue and experienced management. Average in here, too. Things may get rocky over time, but dividends are the best defensive measure available.
  4. Short financials.If you're an aggressive trader, you can short individual banks or the entire financial sector. After all, "they" took us for a ride — why not get even when the tables eventually turn?

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  1. Werner | October 21, 2011

    Very good warning ! However it might be too late anyway. Greece should be allowed to fail. Its "peanuts" compared to other countries, be it in Europe, or to put it bluntly, in the US. Talking of greek default is some kind of diversion. Much worse is to come from the US, the fundamentals are no better there. The political system is just as corrupt and inefficient. So please be open, warn your readers of what to do for the inevitable US default. It is of course much more difficult for a US citizen to flee his country, physically or fnancially, than it is for a Greek, fiscal and political imperialism obliging.
    Just look at the USD/EUR rate, rising despite all the European problems. Not too good an omen! The race to the bottom for fiat currencies is still open with the USD in a hardly contested "first rank".

    • Mario | October 23, 2011

      US is already defaulting – by printing money! And I guess you already have been forewarned in this newsletter about that. Got your gold, silver, and a piece of land from which you can live?…Some skills to trade on barter?…And I mean skills people will really gonn'a need and willing to pay for?…A degree in Art History or Marketing or Paleontology will not gonn'a make it for you, sorry…And ah! by the way – neighter one in Economics!!!!….

  2. Allen Novotny | October 21, 2011

    Sell into strength and do what? When I sell, it automatically goes into a money market fund which is suspect, according to you. I know you give some options where to put some money, but I already have gold stocks and need to deversify. I also have some MLPs that pay dividends. Right now I'm 50% cash and scared since I'm retired.

  3. Tal | October 21, 2011

    Hi,
    You always warn us with bad reports on the U.S. banks but it seems that their stocks are only rising.. When do you think they will start falling down ? It seems that the rally is just beginning. Can it be that all the annalists are wrong with their bad news for the future ? could it be that we should start buying stocks now ?

  4. HAL MCNEELY | October 23, 2011

    It is hard to believe that Greece failing can have any meaningful impact on the US, except for the Mega-banks
    who have been trying to get everyone by the balls; they deserve to wind up with a bag of balls instead of a bag of gold. There has got to be a more rational viewpoint from those who understand the Global Dynamics.
    This appears to be more of a paranoid response, media-driven Chicken Little event, hardly worth any US
    citizen changing their lifestyle voluntarily!

  5. Yngve S. Sognen | October 29, 2011

    I think I get it: Invest in something real, basic resources including farm land, and aquire practical skills.

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