“Greece Will Default” (from May 1, 2010)

Another week has gone by, and the S&P500 has closed virtually unchanged again. Volume was light, and volatility was stuck near historically low levels. Beneath the surface, the breadth of the stock market was not strong—the summation index fell, and the percent of stocks above the 150 day moving average was unchanged. After a big sell-off early in the week, a mere rumor of a “sterilized” QE program from the Fed was enough to reverse the losses and end the week unchanged.

In macro news, factory orders fell month-on-month. The ISM services index rose slightly (after the ISM manufacturing index fell crashed last week). Productivity gains were 0.9%, as expected, but unit labor costs soared 2.8% (quarter over quarter), more than twice as much as expected. Initial jobless claims rose more than expected to 362,000. The US trade deficit last month was far worse than hoped for, causing most economists to lower estimates of first quarter GDP growth. Non-farm payrolls came in slightly better than expected, but almost half the jobs were created by the Birth/Death model from the BLS, and the jobs added tended to be far lower paying jobs than the ones lost in 2007-2009. The unemployment rate did not drop from a still terrifyingly high figure of 8.3%. And average hourly earnings disappointed.

In May 2010, our weekly entry was titled: Greece Will Default. Here’s what we wrote:

To be polite, politicians may not call it a default; a restructuring would be a less distasteful term.  And Greece may not default next week or even next month; still, at some point in the future, it will.

Last week, the inevitability of a Greek default started–and only started–to sink in.  Harvard economist and Ronald Reagan’s Council of Economic Advisors Chairman Martin Feldstein stated the obvious:  “there simply is no way around the arithmetic implied by the scale of deficit reduction and the accompanying economic decline; Greece’s default on its debt is inevitable.  In the end, Greece, the eurozone’s other members, and Greece’s creditors will have to accept that the country is insolvent and cannot service its existing debt.  At that point, Greece will default.”

But the real source of concern isn’t merely the issue of Greece’s credit risk; Greece, after all, makes up only about 2% of the Eurozone’s total GDP.

The real source of concern–and eventual source of panic–is the threat of contagion.  Even before Greece actually defaults, the risk that other PIIGS (and their banks) could also default will grow.  In fact, judging by their surging interest rates, the risk of contagion is already growing.

This means that as Greece topples, Portugal, Spain, Italy, Ireland, and then eventually the UK will also face the strong possibility of “restructuring” their debts.

Sure enough, on Friday March 9, 2012, almost two years after making this prediction, Greece officially defaulted, but wiping out over $100 billion in sovereign debt.

Yes, it was called a “restructuring”. And yes, it took a long time to come to fruition—despite the fact that almost every member of Europe’s elite ruling class insisted, two years ago, that a restructuring would never happen in Greece.

And yes, the worry now is that Portugal and Ireland are very likely next in line to default. What’s worse is that Greece’s debt load—after the default—is now actually greater than it was before the default. Why? Because the post-default bailout funds that will be loaned to Greece are GREATER than the amount of loans that were written down by the default. The result? Greece’s new post-default debt is already trading at yields far above the next most risky PIIGS state, Portugal. In fact, the high yields at which the new Greek government debt is trading imply that the probability of ANOTHER Greek default is already over 90%!

So not only is the threat of contagion now going to grow, as predicted here almost two years ago, but the Greek debt problem itself has not been solved.

What kind of solution is that?

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