Grecian Formula

Despite the thoroughly German ECB being disinterested in bailing out Greece, and the German people overwhelmingly opposed to the same, the German government itself is vowing to help in smaller ways (like buying up newly issued Greek debt so interest rates on Greek bonds don’t spiral out of control).  Not all German officials feel the same way, however.

One German parliamentarian suggested that Greece-owned stock and even unpopulated islands might be transferred to Germany as part of a deal.  The very idea that Greek islands might be on the table, propelled Bild to uncontrollably quip, “We give you cash, you give us Corfu“.

Meanwhile, the so-called “austerity measures” soon to be implemented in Greece seem to be a hit with investors.  Although, in reality, the Greek government is simply raising taxes and cutting spending evenly to total debt reduction equal to 2% of GDP.  That cut in spending is reasonable, but the tax increase is much less useful.  It is highly doubtful at this juncture that a 1% tax increase will lead to a 1% revenue increase.  In fact, it’s probably more likely to lead to a revenue decrease at the rate Greece is going.

Already, tax dodging is very widespread, and the maximum revenue possible from the Greek system may have been reached.  Further tax increases attempting to fill budgetary deficits may find that they have just the reverse effect: as more citizens are disillusioned with the higher taxes they will find ways around paying them (legal or otherwise), and this will lead to continuously increasing tax rates and continuously falling tax revenue.

But if the new plan is a hit with investors, it has only made the Greeks themselves angrier.  Their somewhat newly elected politicians are socialists, elected precisely to not cut spending.  This has left the Greeks themselves feel very vulnerable to the international economic system and to blame other countries, bankers, and politicians as well.  And the Greeks are following their natural inclination of rioting and striking.

If the markets and investors are pacified for a while and the Greek government can continue to rack up debts and rollover its existing debts at serviceable rates, then more of the same is likely to follow.  At some point though, not only Greece but all of the Western governments will need to face the true reality of their deep indebtedness.  Iceland’s failures should have served to wake up bond investors, but the dominoes of bad debt lining up in the Eurozone should be sending off every alarm bell.

Any investors still chasing high yields should expect to get burned.