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Special Report: What is the Greek Debt Crisis, and What Does it Mean for Investors?

With Greece on the brink of default – and hanging over the global economy like a financial sword of Damocles – investors the world over are asking themselves the very same question, day after day: Just what is the Greek debt crisis, and what does it mean to me?

It means a lot.

In fact, the Greek debt crisis could prove to be the first in a series of sovereign-debt defaults that could even infect the U.S. economy, tipping it into a "double-dip" recession and reprising the bear market of 2009.

In short, this crisis is one you need to watch and understand.

Given the stakes, we decided to work with our panel of global-investing experts and put together this Money Morning special report: "What is the Greek Debt Crisis, and What Does it Mean for Investors?"

Our goal was to provide you with answers to some of the key questions about the Greek debt crisis – how it started, what's actually taking place, how it could affect the U.S. economy, and how we expect it to play out.

And with the help of experts Keith Fitz-Gerald, Shah Gilani and Martin Hutchinson, we also answer the most important debt-crisis question of all: "What should you do about it?"

Question: What is the Greek Debt Crisis?

The Greek debt crisis is an expensive lesson in the importance of fiscal discipline – that comes with a multi-billion-dollar price tag.

Due to decades of overspending, Greece is currently receiving a bailout package of $159 billion (110 billion euros) from European governments and the International Monetary Fund (IMF) to meet payment obligations. Greece received its first installment in May 2010, and needs its next $17.3 billion (12 billion euros) loan by mid-July or it won't be able to pay wages or pensions at the end of the month.

Nor does it end there: The European Commission has said Greece will need an extra $166 billion (115 billion euros) through the middle of 2014.

Through the involvement of other countries and financial institutions, this is no longer simply a "Greek" debt crisis – it's becoming a global one. Similar problems plague Portugal, Spain, Italy and Ireland. With the debt contagion spreading, other worldwide players – including the United States – might not escape unscathed.

Q: How Did Greece Get Into This Mess?

Greece certainly didn't create this epic mess all by itself – it had help. Aiding and abetting Greece's own miscues were budgetary machinations by Goldman Sachs Group Inc. (NYSE: GS), a failure by the Eurozone to hold countries accountable for their finances, and credit default swaps that bet against Greece meeting its debt obligations.

But ultimately Greece is to blame.

"Greece lied to get into the European Union [EU]," said Money Morning's Shah Gilani, a former hedge-fund manager who's an expert at "reading" global-capital-movement trends. "After they were in, they used world markets to borrow from investors who bought their bonds, knowing that the EU/IMF would bail them out when it came time to repay. It was a calculated gamble to keep stuffing themselves and raising their GDP/per capita productivity to levels equal to Germany and France. [Greece] doesn't have the productive means to grow to anywhere near the per capita income of the French or Germans. It has olive oil and tourism, what else?"

Under an agreement called the Maastricht Treaty, to adopt the euro as their currency countries had to cap annual budget deficits at 3% of gross domestic product (GDP), and total government debt had to remain at or below 60% of GDP. To appear compliant, Greece failed to book billions of dollars of military expenses, and Goldman Sachs arranged a currency-swap deal in 2001 that effectively cut the country's deficit.

After Eurozone acceptance, Greece violated the terms of the Maastricht Treaty from 2001 to 2006, running excessive budget deficits in each of those years.

Greece's financial mismanagement had been ongoing for decades. Many problems started when the country joined the EU in 1981 – during the administration of then-Prime Minister Andreas Papandreou (father of current Prime Minister George Papandreou).

"Instead of steering the Greek economy to reap the enormous potential benefits of its premature EU membership, the internationally sophisticated Papandreou manipulated the EU system of slush funds so as to keep a gigantic stream of resources flowing to the bloated Greek public sector," said Money Morning Contributing Editor Martin Hutchinson, a former global merchant banker who in the past has helped some European nations restructure their finances. "The result was an economy focused almost entirely on the public sector and tourism (which also benefited from innumerable EU grants), with the populace enjoying living standards far in excess of their ability to pay their way."

The bottom line: Greece spent years borrowing from Europe without offering any real returns to the global economy, creating a country of citizens living well beyond their means.

Q: Will the Bailouts Really Halt a Default?

While European leaders continue to discuss a second round of bailout plans, Gilani said Greece could avoid default – if lenders remain willing to help.

"There won't be any big victims if Greece gets bailed out and their debts rolled out another 30 years," said Gilani. "Were any of the big U.S. banks victims of their own fraud in the subprime smackdown? No. They got bailed out and liquefied. The same could happen to Greece and theoretically there may not be any big victims. As long as there are fingers in the dykes we'll muddle through."

But the country's low economic productivity means Greece will require infusions of external financing every year for years to come. Greece's economy is set to shrink by an additional 3.8% to 4% this year after contracting 4.5% in 2010. Plus, the bailouts have let Greece believe it can lean on the EU to fix its problems.

Many experts, including Money Morning Chief Investment Strategist Keith Fitz-Gerald, believe Greece should be forced to face up to its lack of fiscal discipline – meaning the bailouts should end. But if that happens, the fallout – and the pain – will be widespread.

The bottom line: The risk of default is much greater than the headlines would have you believe. And if there is a default, the U.S. economy won't escape the fallout.

Q: What Does This Mean for the Euro?

One of the lessons we've learned from the Greek debt crisis is that the Eurozone is not as strong or stable as most believed. Eurozone members attempted a monetary union without united fiscal policy. Now it must strengthen membership standards to prevent future crises.

"If the EU wishes to make the euro work, it must demonstrate that the fiscal rules of euro membership have teeth," said Hutchinson.

That's been tried before – to no avail.

The euro's stability was based on a pact among members to keep their finances in order. In 1996, countries voted on imposing fines on countries that didn't adhere to the Eurozone's standards. But that motion was struck down and no "punishment" ever came about.

The bottom line: Greece isn't the only euro "bad boy." Other countries also have failed to meet the Eurozone standards at least once; but certainly none as extreme and frequent as Greece. In fact, the Eurozone as a whole has never met the 60% of GDP government target. And Eurozone policies weren't enforced.

Q: What's Next in the Greek Debt Crisis?

As you're no doubt beginning to see, the question "what is the Greek debt crisis?" may actually be too narrow a query.

Moody's Investors Inc. (NYSE: MCO) just cut Portugal's debt rating to below-investment-grade status ("junk" in the parlance of Wall Street). And that move roiled the bonds of Spain and Italy, two other high-debt nations that have been the focus of major solvency worries. Ireland is also causing lots of sleepless nights for debt-holders.

"The real problem is that Greece is only the first domino," Gilani said. "In order to support the rest of the ailing peripheral Eurozone countries, the European Central Bank, all the European banks, the IMF, the U.S. and China are going to have to come to the rescue. Unless there is some new model for achieving solvency with liquidity that comes from the Chicago School of Impossible Economics, the euro is toast and the whole experiment of European Union will be tested from the corners and its center."

Hutchinson said Portugal and Ireland are productive enough to solve their problems through austerity, although there's no guarantee. Italy will be a tight squeeze. In an ideal world, Spain would get a badly needed new government – one that would put in place the measures needed to avoid default. And Greece would be booted out of the Eurozone, he said.

The bottom line: The Greek debt crisis is more of a Eurozone debt crisis.

Q: Could the Greek Debt Crisis ‘Infect' the U.S. Economy?

Let's just cut to the chase here: The answer is a resounding "yes."

Greek's debt problems have an excellent chance of going global, not just because of an economic ripple effect, but because other countries like the United States are also getting carried away with high debt loads.

"What's happening in Europe is already happening here," said Gilani. "So, it's not so much a problem of infestation, it's more a matter of manifest destiny."

All of this is widely known. But the largely untold "rest of the story" is this: If the European banking sector implodes, the U.S. financial system could take an unqualified beating.

Big U.S. banks have been lending generously to banks across Europe. Close to 29% of their lending books during the past two years have gone to their heavyweight European counterparts. While they have pulled back considerably as a result of recent turmoil, U.S. banks are widely believed to have $41 billion of direct exposure to Greece.

The amount of exposure to the rest of Europe is not easily quantifiable. And this U.S. financial system link doesn't end there: U.S. money-market funds have a hefty European exposure, too.

The bottom line: The U.S. Federal Reserve and other regulators are right now reviewing "contingency plans" in case the widening European debt crisis fires off another run on the $2.7 trillion money-fund sector – a situation we saw back in 2008. But insiders admit that it may be a lot tougher to craft an effective response this time around.

Q: As an Investor, What Should I Do?

Although it's not clear how the Greek debt crisis will play out, you should run through a "Greece safety" checklist to avoid exposure to the heart of the crisis and increase holdings in safer and more protective investments.

Our experts suggest taking the following steps:

  • Stay away from European banks – they're on the hook for $100 billion.
  • Avoid southern European debt, as well as U.S. Treasuries and Japanese government bonds – they're no safe haven.
  • Don't ignore Europe entirely – there are some worthy German and Swedish non-bank stocks.
  • Look to energy-related investments, commodities and precious metals, all of which have bullish long-term outlooks.
  • Use protective stops.

One final note: If you have comments about this report, or additional questions about the Greek debt crisis, feel free to e-mail Money Morning at Make sure, in the subject line, to use the phrase: "What is the Greek debt crisis?"

[Bio Note: In a recent interview, investing icon Jim Rogers made this sage observation: "Whenever there's a catastrophe, there are also massive opportunities."

In this case, Rogers was referring specifically to the Japanese earthquake and nuclear disaster. But that powerful bit of wisdom is just as true for the Greek debt crisis.

In this special Money Morning report, we give you some solid investing guidelines that will help you navigate the Greek debt crisis. But perhaps you'd like more – including some specific investment recommendations.

If that's the case, you should take a look at our affiliated newsletter, "The Money Map Report." Each month, our gurus scan the globe in search of the best strategies, profit opportunities, and defensive investments. The Greek debt crisis has been – and will continue to be – a major theme behind many of our best ideas.

To find out more about "The Money Map Report" – and about a limited special offer we have in place right now – please click here.]

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Join the conversation. Click here to jump to comments…

  1. dionysios dallas | July 7, 2011

    Well sir…the million dollar question is why did European banks buy Greek Bonds or even American…nice returns; don't tell me they didn't know what was happening as you mentioned yourself that Goldman Sach's had a hand in it with a nice retainer.
    What Europe has failed to do is to monitor each countries hand-outs closely by putting their own staff (25,000 beauracrats making fat salaries and who knows what else) and as they are doing right now with the new loans.

  2. Effie | July 7, 2011

    I understand the bad management an bad financial structure when Eurozone atempted Monetary Union without Fiscal Policy. It will be fine to have European Central Bank, all European Banks, IMF, the US an China to help Greece, but what about Portugal, Spain, Italy an Ireland??? I see
    that what those countries need is a long term loan (30 years) combined with a massive plan
    to increase its productive means to grow and meet the Eurozone Standards. Those Countries
    has to learn how to spend and also learn how to offer a real rate of returns to the Global Economy, not just living well beyond their means an ignoring the rest of the World, or at least
    to bew commited to the Eurozone Standards.

  3. Adán Salgado | July 7, 2011

    Well, Mr. Shannon, I think that what we have now is a terminal case of chronic capitalist disease, because, after all, heavy indebted nations and persons are what this savage economical system is always looking for, no? I mean, for capitalism is essential, fundamental, that society consumes whatever is produced, so, if liquidity is not enough for that excessive consumption, excessive credit comes side by side, like, for example right now is happening in the USA and in many other countries, that are heavy indebted for the next 40, 50 years to come, no!? But there are always big winners in all this mess and they are the big banks, "investors" and big corporations that are so favored that nations and people fall in total disgrace. Thanks for your kind attention.

  4. Steve_in_Australia | July 8, 2011

    Sir, a few comments.
    1. You say Greece is about "olive oil and tourism and what else”. Well, Greece has the biggest shipping fleet in the world, representing 18% of the world’s shipping capacity and ranks first in tankers and oil carriers. 80% of the economy is services, like in any modern economy.
    2. Spain is mentioned as “another high debt country”. Actually its debt is 63% of the GDP (Britain’s is 60%, USA 69%).
    3. An interesting question is what would happen to the Euro if indeed Greece defaulted and left the Euro zone. Such an event could indeed trigger a domino effect and perhaps Portugal and Ireland would also leave. This would be a major shock to the European and US banks and could easily trigger a GFC2. But why would the Euro be “toast” as you say? The opposite is more likely: without the weak links the Euro would shoot up. This is actually often mentioned as a major risk for the Euro Zone, as the high Euro would be bad for texporting countries like Germany and France.

    • JAMES | September 14, 2011

      Dear Steve,
      you r absolutely right of every word you wrote. But thanks to Goldman and ministers Papandreou and the son (like US Bush and Junior) for the US people the local currency( USD Dollar)will rise up to the sty and it will be again the number one currency all over the world….cause i can see the 1 euro will be = 1 USD at the end of this year.
      This is a currency war and we cant do nothing about it because all the decisions where made before even the euro rise from the head of some clever people. Many thanks to US and gold save our King Papandreou.

  5. Andy Vranich | November 2, 2011

    Is the U.S. stock market a good place to park ones retirement fund if NOT WHERE????????????????

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