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As Greece's Woes Demonstrate, the Fuse Has Been Lit on the Global Debt Bomb

The big story in the international markets so far in the New Year has been the increasing shakiness of a number of countries' government bonds, with Greece right now being the most troubled of all.

Since U.S. investors tend to avoid foreign government bonds, many will dismiss this as an irrelevant development.

That's a mistake. The reality is that the international implications of this bond-market problem are serious for the world's stock markets, as well as for the global economy as a whole.

The fuse has been lit on a global debt bomb. And Greece has quickly become a poster child for the explosion that's all but certain to occur.

From its entry to the European Union in 1981, until the arrival of even weaker Bulgaria and Romania in 2004, Greece was the economic weak sister of the mostly rich countries in the EU. Its original entry was prompted by a wish to reward the country for getting rid of its dictatorship in 1974, while remaining a member of NATO and not succumbing to the blandishments of Russia and the Warsaw Pact (its neighbors were all of Communist persuasion, in one form or another).

For most of the 15 years after its EU entry, Greece was run by Andreas Papandreou, one of the most unreconstructed socialist politicians of that generally free-market period.  As a result, despite having had a head start of 23 years on the Central European countries that entered the EU in 2004, its economy was both more indebted and poorer than most of them.

Greece entered the Eurozone (the nations that use the euro monetary unit) in 2000, but had to fudge its figures to do so. It then violated the terms of the Stability Pact from 2001 to 2006, running excessive budget deficits in each of those years. It satisfied the criteria in 2007, then blew them out altogether by 2009, a year in which its budget deficit equaled 12.7% of gross domestic product (GDP). By the end of that year, Greece's public debt had reached 108% of GDP – lower than that of Italy and Japan, but with no obvious sign that it would soon be brought under control.

It came to a head last month.

Greece's financing needs – $48 billion for 2010, or about 15% of GDP – caused disquiet among investors. Spreads of medium-term Greek debt over comparable German paper widened to nearly 4%.

Since Greece has fiddled its figures and run excessive budget deficits, it is technically ineligible for an EU bailout. German Chancellor Angela Merkel – at least for now – is resisting imposing this additional burden on German and other EU taxpayers. There is a sporting chance of an International Monetary Fund (IMF) bailout – though not for $48 billion. And Greece reasonably would prefer to avoid the rigors of mandatory IMF advice when it can probably squeeze money out of the EU by threatening to destabilize the euro.

In terms of balance-of-payments imbalances, there are European countries in worse trouble than Greece: Latvia springs to mind – but Latvia is not a member of the euro, and has the excuse of the transition from communism. In any case, Latvia's record over the last two decades is one of admirable devotion to free-market principles and a resolve to put its house in order – very different to the panhandling Greece. So a Greek default on its foreign debts is both more likely than a Latvian default and more dangerous for the international markets.

A simple default by Greece would probably not be too damaging, except to Greece's Mediterranean neighbors: Italy, Spain and Portugal (together known as the "PIGS," a very different collective from the fast-growing "BRICs"). However, a default that was accompanied by Greece's forced exit from the euro – on the grounds that it had become hopelessly uncompetitive – would bring the stability of the euro itself into question. That would be hugely damaging to world confidence, since the U.S. dollar, the Japanese yen and the British pound don't look too solid, either.

The other PIGS are not much better off than Greece. Overall, Portugal is probably the best run of this group. But it currently has a budget deficit of 9% of GDP and a current-account deficit of 9% of GDP. Its public debt – at only 75% of GDP – is a bit more tolerable.

Spain has suffered an enormous real estate downturn (but not a complete banking collapse, because the Bank of Spain was far more cautious than the U.S. Federal Reserve in the leverage it allowed local banks during the boom).

However, Spain right now has a poor quality government, a budget deficit of 12% of GDP and 20% unemployment – not a good combination. Italy has the highest debt – at 115% of GDP, but its management is better than it appears, and its budget deficit is only 5% of GDP. So after Greece, Spain – rather than Portugal or Italy – appears to be in the most trouble, even though its public debt is only 60% of GDP.

Mind you, one doesn't have to be among the PIGS to be in danger of default. Britain has a budget deficit of 14% of GDP – and no obvious plan to reduce it. Japan has public debt equal to 200% of GDP, and a budget deficit that is rising.

And, of course, there's always the United States to worry about.

As the global debt bomb builds, it seems increasingly likely that the international bond markets will see a major national default during the next couple of years. The favorites right now would seem to be either a Eurozone member, or perhaps Britain or Japan.

If that happens, we'll see risk premiums widen in the world's bond markets, making money more expensive. Usually, the rich countries end up benefiting from tight money. Not this time, however. Most of those "rich" nations have budget difficulties (Australia and Canada are the exceptions).

When the international debt bomb blows, it will be China and other Asian exporters that will reap the benefits. They have the huge foreign exchange reserves needed to do so. As a result the global balance of power and money will lurch still further in their direction.

[Editor's Note: Martin Hutchinson has terrific foresight. He warned investors about the dangers of credit-default swaps – half a year before those deadly derivatives ignited the worldwide financial firestorm. Hutchinson even predicted where and when the U.S. stock market would bottom (a feat that won him substantial public recognition).

During the stock-market rebound that started in mid-March, Hutchinson's calls on gold, commodities and high-yielding dividend stocks made winners of investors who took his advice.

Experts are taking notice. And so should you.

Hutchinson is now making those insights available to individual investors. His trading service, The Permanent Wealth Investor, combines high-yielding dividend stocks, gold and specially designated "Alpha-Bulldog" stocks into winning portfolios.

To find out more about The Permanent Wealth Investor, please just click here.]

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  1. George | February 4, 2010

    "As a result, despite having had a head start of 23 years on the Central European countries that entered the EU in 2004, its economy was both more indebted and poorer than most of them."

    Greece is richer than any of the countries that have joined the EU from 2004 onwards.

  2. Euro Bug | February 4, 2010

    Something that is always missed when talking about I taly is that it has the highest gold reserves in Europe desite pressure from the EU to reduce them;and long may it do so

  3. Philippe de Massia | February 4, 2010

    Hi.
    Here are some things I'm thinking about and that are never mentionned.
    Aging of the world's population, and that China has a serious birth problem (woman don't want kids and one woman per 100 men…)
    This will have a serious affect on housing, more available, less people to put in…
    These are serious issues to adress for the economy and the future generations to come…
    Are we avoiding the question?

    I still have many questions in mind.

    Thank you

    Philippe de Massia

  4. Sean Lawrence | February 4, 2010

    While am concerned about Greece and others, I am more legitimately worried about the rise of China as a result of the US routinely exporting jobs and importing everything else. At some point one has to have a hand in the building of the goods they consume. That huge sucking sound is the whole American population shopping at Walmart.

  5. spadice | February 4, 2010

    Due to debt problems of Greece, Spain and Italy and other European countries in the waitingroom de Euro will fall sharply on the orher hand gold will soar to new highs.

  6. JOSEPH FOSTER | February 4, 2010

    Before we find fault with Greece and others, why do we not focus on?
    The fault of the USA that wants to become in the future an Agriculture based economy and return to poverty status.
    When the Industrial revolution began it made the US one of the wealthiest countries amount the other G7 but now the US has decided that they no longer deserve such wealth, it is now the turn of Asia to become the Industrial
    Countries of the world and Americans shall be the buyers of the product produced. Prior to 1980, the Asian countries were buyers of the product produced in America,
    The fall of any country is the result of debt, and its quest to extend its geo political influence by foreign aid it cannot afford.
    Greece is only one of the 27-member states of the European Union and its demise will not have a significance impact on the EEC.
    What about 43 states that is also bankrupt, since some of them wants to pay police officer’s $200,000 per annum.
    The milking cow for their revenue was the homeowners property tax, that milking cow has now run out of milk.

  7. Peter D. Hunter | February 4, 2010

    OK. So how can we short credit default swaps that have most exposure to Greek debt?

    Pete Hunter

  8. Damian | February 4, 2010

    So Greece is the only country that has "fiddled its figures"?

    Their biggest problem now is they don't owe enough to really hurt creditors with default.

    But when you owe 10's of trillions the burden of debt is reversed.

  9. H. Craig Bradley | February 4, 2010

    PUMP AND DUMP ASIAN STOCKS

    Why is just about ever article on this website a variation of financial doomsday, at least for the Western Developed Economies? I detect an Asian bias here? Is this website paid for by the International banking cartel? Right now, we appear to be in a deflationary period (deleveraging) of possibly long term duration.

    If inflation resurfaces, it probably won't be anytime soon. Asian markets are looking pricier all the time. Generally, a hot asset class last year (emerging markets) may dissapoint the following year. It is not usually a great idea to follow the herd. Moreover, no matter where in the world you buy an asset, it is near impossible to make much money if you overpay for it.

  10. Panayotis Economopoulos, MA, Ph.D | February 4, 2010

    The Greek problem is blown out of proportion for speculative reasons. 40% of Greek GDP is unreported and not counted when compared to public debt. It is a mistake to consider only the public component of the country debt. The private component is only 90% of GDP. Compare this with the cases of Britain, USA, Italy even Germany!!! The EE can help Greece reduce these spreads. Austerity measures have never managed to take a country out of recession! Get serious.

  11. Mike Furst | February 4, 2010

    Ah, Geez! In China, a ratio of women to men of 1:100? Where do people get this kind of silliness? Yes, the ratio is unbalanced but its more like 1.06. That means that for every 100 females, there are 106 males.

  12. DAVID THIBODEUX | February 7, 2010

    THE US KNOWS THAT INDUSTRI REQUIRES HUGE AMOUNTS OF OIL , MAYBE THIS IS WHY IT SEEMS THE US IS SO CRAZY LETTING ALL THESE FACTORIES GO OUT TO OTHER CONTRIES BUT NOW CHINA IS SCRAMBLING TO GET ENOUGH OIL TO KEEP UP WITH DEMANDS , AND HAVE YOU NOTICED HOW CLEAN OUR COUNTRY HAS BECOME IN THE LAST 20 YRS, BECAUSE OF EMMISSIONS STANDARDS NOW OUR CONTRY IS VERY CLEAN I HAVE BEEN TO 3 OTHER COUNTIES AND IT IS POLLUTED AND AIR IS DIRTY, SO NOW CHINA HAS ALL THESE SMOG PROBLEMS,YEAH IT SEEMS COMMOTIDIES ARE A SAFER BET LIKE OIL IT IS SO COMPLEX I DONT THINK ANYONE REALLY KNOWS

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