Greece: The 'Debt-Line' Is Near

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There has been much talk about Greece defaulting on 20 March 2012. I can't agree more on that statement. By March 20 , Greece needs to pay US $18 billion in bond payments. In 2014, their US $100 billion debt matures. Here's why I think they won't be able to pay off their debt.

The Greece balance of trade has never been positive in the last decade, which means the country never made any money (see chart 1), though there has been some improvement since 2008. Even so, the country have a deficit of US $3 billion a month. How can it pay for US $18 billion in bond payments, if it can't even be profitable as a country. Likewise, Greece's current account is still in a deficit of US $3 billion a month.

Click to enlarge

Chart 1: Greece Balance of Trade

Since 2008, Greece's GDP has also been contracting (see chart 2). So there are no prospects of the country growing its economy, especially when Greek citizens are on strike almost every day now. When economies don't grow anymore, and have huge debts alongside, the fun is typically over.

Chart 2: Greece GDP Annual Growth Rate

When countries need to sanitize, they should cut spending and increase savings. But while looking at the Greece government budget (see chart 3), we see that the government isn't cutting spending. It is in fact spending more than it receives in taxes. This is not surprising, as Greek citizens are not working, which means less income for the government.

Chart 3: Greece Government Budget

Chart 4 tells us that there is no chance that the government budget will improve, as unemployment is skyrocketing. If nobody is working, no money will be generated by the workforces and no money will flow to the government in the form of taxes.

Chart 4: Greece Unemployment Rate

Additional evidence of deteriorating government income can be seen in Greece's industrial production (chart 5). Greek industrial businesses have posted a negative growth rate since 2008.

Chart 5: Greece Industrial Production

As a result, Greece government debt has gone up exponentially since 2008 (see chart 6).

Chart 6: Greece Government Debt to GDP

With Greece government debt skyrocketing, foreign bondholders have lost confidence and are asking for high premiums for lending Greece their money. To lend money for 10 years, they ask 35% yields (see chart 7). For 2-year bonds, they even ask as much as 200% (which is basically a 100% default).

Chart 7: Greece Government Bond 10Y

If Greece were to default, there would be turmoil on the markets, especially for these 40 top holders of Greek government debt (see table 1). The most exposed are, of course, the Greek banks themselves: National Bank of Greece (NBG) and Bank of Piraeus (OTCPK:BPIRF). After those, Belgium has a significant share in Greek debt under Dexia (OTC:DXBGF) and BNP Paribas (OTCQX:BNPQY), which concerns me as I live in Belgium. Then we have the German bad bank, FMS. Luckily, it has already written off these losses to an extent.

Table 1: Top 40 holders of Greek government debt

So what is the solution for Greece?

Greece could start introducing the drachma, alongside the euro, and have dual currencies, which is not uncommon. This solution has also been adopted by Marc Faber (for example, in some parts of China you could pay with Hong Kong dollars or in Chinese RMB. In Cuba, you could pay in dollars or in pesos).

What will happen is that the rate of exchange will be determined by the market. The euro and drachma will co-exist, and liquidity will increase in the market. Instead of an immediate inflationary shock, we get a gradual market-based stabilisation in the drachma. Eventually, the euro will disappear from Greece, and the drachma will be prevalent due to Gresham's Law.

We've seen this happen many a time all across the world. In Vietnam for example, the dong is prevalent, because nobody wants it. People flood the market with bad money and store the good money (gold) at home. The same will happen with the drachma.

So basically, we will get an orderly exit of Greece from the eurozone. In this scenario, I see the euro strengthening over time. Debt would still have to be paid in euros, and the drachma would become highly inflationary.

Of course, this will not be happening anytime soon as the Greek government will want to keep getting free money as long as the situation lasts. But this free money won't be available forever.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.