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A Greek Default is Bad – But a Greek Bailout Much Worse

[Editor's Note: We want to hear from you! Do you have a comment, suggestion, story idea or question? Let us know at (**) And be sure to check back for responses to reader questions and comments.]

Many investors continue to favor a Greek bailout to prevent the Eurozone's first sovereign default – but they are rooting for the wrong solution.

Greece has requested another loan from its European neighbors to cover next year's $43 billion (30 billion euros) shortfall as yields on 10-year Greek bonds have climbed over 16%.

The second Greek bailout would come about a year after the European Union (EU) and International Monetary Fund (IMF) loaned the struggling country $158 billion (110 billion euros) to meet soaring financial obligations. Greece took the money on the terms that it would implement austerity measures and cut its massive budget deficit, but the country failed to meet the agreed-upon targets.

EU and IMF officials have been reviewing Greece's cost-cutting actions to determine if the country – now with about $430 billion (299 billion euros) in debt – deserves another huge loan. EU leaders have also considered asking investors to reinvest in new Greek debt when existing bonds mature, buying time to stabilize Greece's sinking economy.

EU policymakers are doing everything they can to avoid restructuring Greece's debt, which is considered tantamount to default. The default risk rose Wednesday when Moody's Investors Service (NYSE: MCO) downgraded Greece's credit rating to Caa1 from B1, putting the EU country on par with Cuba.

Moody's said Greece's failure to improve its debt situation after last year's bailout, as well as the continuing rise in bond yields and the inability to tap private markets for capital, point to a higher chance of default.

"Taken together, these risks imply at least an even chance of default over the rating horizon," Moody's said in a statement. "Over five-year investment horizons, around 50 percent of Caa1-rated sovereigns, non-financial corporate and financial institutions have consistently met their debt-service requirements. Around 50 percent have defaulted."

Indeed, a Greek default would have enormous consequences, and Money Morning Contributing Editor Martin Hutchinson recently said it could be worse than the Lehman Bros Holdings Inc. (PINK: LEHMQ) collapse in 2008.

But the global effects of a Greek bailout would be much worse than default, according to Hutchinson. He explains why investors should favor a Greek default instead of a bailout in the following answer to this Money Morning Mailbag question:

I'm not invested in any stocks or bonds directly related to Greece, or European banks, but I'm worried about how a Greek default would damage my portfolio. Is a bailout safer for investors?

— M.M.R.

Martin Hutchinson: Markets are more or less panicking at the possibility of a Greek bailout, or indeed a Greek default. The thing that investors should take away is the idea that a Greek default would be much better for them than a Greek bailout.

You see Greece has basically been living "high on the hog" of European subsidies since 1981 when it joined the EU. As a result, its people have ended up with a gross domestic product (GDP) per capita of about $30,000 a year; in other words, very close to the median of EU GDP per capita.

That's a problem because their productivity doesn't get anywhere near reflecting this. For one thing, they all seem to retire at 52.

So, therefore, what needs to happen is the Greek living standards need to decline about 30% or 40% in order for them to produce enough to support them, assuming the EU isn't going to just pour money into the place ad infinitum. And you've therefore got a problem because an EU rescue merely perpetuates the subsidies and is a huge extra tax on the better countries of the EU like Britain, Germany, and France, whose taxpayers are expected to support all these deadbeats.

Whereas a default – and that would I think require Greece to leave the euro – has absolutely no costs to international investors who aren't invested in Greek debt. Some of the European banks would have problems, but if you don't have shares in those banks, you don't have a problem.

As was the case for Lehman Bros., a Greek default would require another bank bailout, another period of cockeyed fiscal and monetary policies, and another major recession. The only difference this time around is that the global recession and bailout will be centered on the EU – as opposed to the United States. And that's at least a small bit of comfort to us American taxpayers.

As Americans, quite frankly, we should be glad that the banking problems extend beyond our own ghastly institutions.

So the bottom line is you should welcome a Greek default and you should curse if you get a Greek bailout. Of course, the EU being what it is and the IMF being what it is, I would expect there to be a bailout.

[Editor's Note: As a global merchant banker Martin Hutchinson guided clients, companies and even entire countries by capitalizing on near-term opportunities, and by riding long-term trends.

Because of its impact on commodity prices, both in the near term and over the long haul, the rising global population requires Hutchinson to search for those more-immediate profit openings, while also scouring the horizon for the long-term trends that can create the hefty profits investors seek.

Indeed, in his "Permanent Wealth Investor" advisory service, Hutchinson has identified one particular global economy that meets all his requirements, and represents such a rich profit play, that we couldn't give it – or the investments he's recommending – away for free.

To find out more about these investments, and Hutchinson's service, check out this link.]

(**) Money Morning editors reserve the right to edit responses for grammar, length and clarity when posting on our Website. Please include your name and hometown with your email.

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  1. dionysios dallas | June 3, 2011

    can you tell us what will happen to USA after the end of QE2 this June

  2. Ventureshadow | June 3, 2011

    Their politicians will do what politicians always do–whatever it takes. Whatever it takes to get them reelected, that is. False promises will be the foundation for what happens in Greece–and everywhere else.

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