Thursday, 25 August 2011

The likelihood of a default is real

We at Renomic has concluded that the likelihood of an European country is real now. The possible candidate will be Greece. We not saying that it will be soon, but as pointed out recently by some experts and economist, the likelihood of default for the next 5 years is highly possible. Yes, we know that ECB and IMF, as well as some European countries are trying their best to savage the situation. Of course the second rescue package for Greece was agreed in July, and it should ease the tension of an immediate default by Greece. However, we have to face the fact that it is really quite impossible to service your debt if you have to pay higher interest, as well as paying a premium to get your debt insured. Looking at the 2 year and 10 year bond yield, you know that it is insane to borrow at that kind of interest out in the open market. Market forces seem to be ignoring their rescue packages and rather position it at its reality. Also, the problem is no longer isolated in Greece, but rather had spread to other member countries. See the effect of it now after it had spread?

Let say they need to pump in cash into the rescue package, and should be contributed by member countries in European Union. Presuming that they decide to print more money. As a result, money supply will definitely increase. For those who studied Economics during their academic journey, you should know that increase of money supply will increase the likelihood of inflationary pressure and indirectly devalued your currency since we no longer have gold standard accordance to the Bretton Wood Agreement in 1971. There was an article few months ago stating that one of the solution for Greece debt woes is to devalue the currency and print more money. They cannot do that since they are part of a member group which share the same currency.

Another interesting point noted was that ECB has recently bought some of it's members' bond in the open market in view to keep interest rate pressure down. Think about it, how long can they do it? How far do they expect this to go? The problem originated from Greece now had evolved into a group problem in the region. As far as Euro as a whole, the main solution should be beneficial to the overall stability of European Union, and not seen as a lifeline saver for a particular country. In this way, Greece may not be the main priority in future. Although the Greece had taken harsh austerity measures to curb the rising deficit in exchange for a second bailout, this will for sure cause the country into a long term recession and will further damage their fragile economy. In any view you see it, chances of Greece bouncing back is getting even impossible now.

Back to basic, when you have high deficit and decide to cut your spending, as well as unemployment, revenue will be hit since people are jobless and are unable to pay their tax. People will cut their spending too. Without spending and coupled with other factors, country may face long term recession.

Whether or not they will default, three of the biggest rating agencies had rated Greece the lowest possible grade before default. Seems like they are not convinced too.

Renomic 

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