Greek Debt

Last month, I wrote a piece on interest rates on Greek bonds.  I wrote that Greece will likely default on its government debt.  It was a popular piece.  People are paying attention to this.  Even Americans realize that there are ramifications elsewhere.

As of today, the interest rate on a one-year Greek bond is over 150%.  This means almost certain default, unless there is a massive bailout.  But even a massive bailout will only buy time.

This means if the government of Greece issued a one-year bond today for, say, one million euros, then it would end up paying back 2.5 million euros over the course of the next year.

Let's use an analogy for this.  Let's say there is a family with huge credit card debt.  The family makes $50,000 per year after taxes and makes the minimum monthly payments on its credit card debt, which amounts to $1,000 per month.  The problem is, after the family pays for its monthly expenses of housing, food, clothing, and other things, they only have $800 left to pay the credit card bill.  So the family uses even more credit card debt, just to pay the minimum monthly payments.  The family's debt is getting larger and larger and the interest rates keep going higher and higher.

Eventually, the credit card companies would stop lending money to this family and the family would end up in bankruptcy unless it could drastically cut its regular monthly expenses.

In the case of Greece, there is minimal cutting right now, although I'm guessing many of those on the welfare train there would disagree with me that it has been minimal up to this point.

Instead, the Greek government is trying to raise taxes and this will only result in more productive people leaving the country.

The Greek government is like the family in credit card debt.  It can barely make its minimum payment each month.  It has to borrow more just to pay the interest.  I can see no other reason why the government would be issuing debt that pays 150% interest.

Perhaps there will be another bailout, but this will only delay the day of reckoning.  The default is coming.  This is significant and yet Greece is small compared to others.  Italy's debt-to-GDP ratio is almost as bad as Greece.  Of course, Japan is far worse than both with a ratio of over 200%, yet that country is still going without default.

Greece cannot print money.  It needs the European Central Bank to do that.  But if the ECB does too much money creation, then countries like Germany will revolt.  The people will revolt, not the German government.

Greece will default.  Others may follow.  The euro may break up.

For American investors, it leaves a question of what to do.  If these events unfold quickly, the U.S. dollar may strengthen in the short term.  It is difficult to say what will happen with gold in the short term.  It depends on what people view as a safe haven.  Gold may struggle because of a strengthening U.S. dollar or it may do well as people buy it as a crisis hedge.