Greeks bearing rifts

 
What's that adage? If the US sneezes, the world catches a cold? Well, Greece has the full-blown flu and if its neighbours go down with it, Australia should be worried, writes David Potts.
They aren't on eBay yet but bargain-priced Greek government bonds are bound to pop up soon. Not that they would be a good buy. Although they promise a yield of more than 16 per cent for 10 years on paper, the truth is they're worthless unless you want to add them to your collection of US 19th-century railroad certificates, East German marks or One.Tel scrip.
That Greece was able to con the big European banks into lending so much for so long is a story in itself, though its telling porkies about the state of its public finances has given them a good excuse.
But that's banks for you. Request a trifling loan and you'll be dragged through the hoops and maybe turned down. But ask for $50 million with no prospect of repaying it and you'll be feted.

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Anyway, France's biggest banks are owed $US23 billion ($21.7 billion) and Germany's $US15 billion. And that's just a pittance compared with more than $US1 trillion owed to them by Ireland, Portugal, Spain and Italy, all with big debt problems.
No wonder the markets smell blood. And by striking at the international banking system, Europe's woes are also ours.
Who could forget the subprime crisis in the US undermining banks around the world? It triggered the global financial crisis, devastating share prices and super returns. As it turned out, many of the victims were in Europe. Northern Rock in Britain, for example, was one of the first GFC casualties.
So, it's anybody's guess what the knock-on effects of the European debt crisis will be, especially considering Europe and the US haven't fully emerged from the first GFC.
Speaking of guesses, one of the few economists to predict the GFC, Professor Nouriel Roubini, says there's a one-in-three chance the European debt crisis, US budget deficit, a slowdown in China and stagnation in Japan will create a "perfect storm" in 2013.
Recession, here we come.
Hang on, he also said there was a one-in-three chance it wouldn't happen and the third possibility was that things will improve.
He was more definitive last week: "Although Greece was bailed out a year ago, plan A has clearly failed. Greece will require another official bailout, or a bail-in of private creditors."
The trouble is the European Central Bank won't buy plan B.
The problem for the financial system of a default by Greece, or in this case a pretend-it-isn't-a-default, is not that it could happen – Russia, Mexico and Argentina did without precipitating a GFC – but that the longer it's postponed, the more the markets will worry.
They call it kicking the can down the road. That can is a ticking debt bomb that could go off at any time. It could just as easily land in Portugal, Spain, Belgium or even Italy.
If there's one thing the GFC showed, it's contagion is as unpredictable as it is uncontrollable. For a real fright, try Japan, the second most important economy to Australia after China. Where Greece's government debt is about 150 per cent of gross domestic product, Japan's is 229 per cent.
But the markets wouldn't dare round on Japan because "less than 5 per cent of its debt is held by foreigners," says the head of investment strategy and chief economist at AMP Capital Investors, Shane Oliver.
Unlike Greece, Japan is also blessed with massive foreign-exchange reserves.
But back to Europe, where there will be a European Stability Mechanism for private creditors if a member country gets into strife, officially described as a "new permanent crisis mechanism", which says it all. It doesn't even kick in until 2013. Greece might be happy to wait – but the markets won't be.
The fact is Greece's situation is worsening. Its economy is shrinking by more than 4 per cent a year, which only compounds its budget deficit and debt problems. The other so-called periphery countries – which is all of them, except Britain, Germany and France – also have to cope with rising interest rates, fiscal austerity and, for them, an overvalued euro.
Nobody wants to say another GFC is coming but since most of the original debt problem has merely been shifted from the banks to governments, both in the US and Europe, the truth is it never went away. The banks have been made stronger but overvalued European bonds, along with falling property prices, are weakening their capital positions again.
The problem with France and Germany helping out their banks is that it adds to their own sovereign debt.
This time, China is riding to the rescue. Premier Wen Jiabao has told Europe that China is happy buying European government bonds and only the other day helped Hungary with a small debt problem.
China has bloated foreign-exchange reserves, which have been caused either by an undervalued currency or the US pumping greenbacks into the world because of its huge budget deficit (or a bit of both, most likely), so there's no problem there.
And the fact Europe is China's biggest customer, and so the source of its own spectacular growth, gives it a vested interest beyond politics to help out.
Besides, the Chinese don't like the fact their foreign reserves are so heavily invested in low-yielding US government bonds, so are keen on seeing a strong euro.
This backing gives the European banks liquidity that was missing during the GFC.
But China has potential debt problems of its own. Its property bubble is bursting and that could hit its banks hard by reducing the value of the collateral of their loans.
Falling property prices would also cut its growth rate since its major industries depend on construction and so, ultimately, land values.
So, China's banks might become forced sellers of European bonds themselves down the track.
What was that about 2013 again? As the can rolls down the road, the Bank for International Settlements (the central bankers' bank based in Basel) says the task of avoiding a second GFC is going to be enormous because of "towering debt" along with "extremely low" interest rates.
It also points out that money movements between countries have become "staggeringly large" and "a sudden reversal of such flows could wreak havoc with asset prices, interest rates and even the prices of goods and services in countries at both ends of the flows."
Sound familiar? As the GFC proved, Australia is considered risky when money markets freeze up. The smart money, or rather the scared money, heads straight for the safe US bonds that, despite the debt problems of the US, are the bedrock of the financial system.
Unfortunately, this retreat to safety rules out any wonders from the sharemarket for an indeterminate time. But all is not lost. I hear the Acropolis is going for a song.

Term deposits grease the wheels for banks

Notice there hasn't been a peep from the banks lately about their rising cost of funds, the excuse they kept using for lifting rates by more than the official amount?
Yet the Greek debt crisis has been pushing up the cost of borrowing in wholesale money markets, from where our banks obtain about half their money to lend.
If an eventual default by Greece is going to hit us, it will be via the banks. But they've had help from an unexpected quarter: us.

So much money is being stashed into term deposits that the banks have been quietly lowering rates on them. And the market is saying the Reserve Bank needs to cut rates if the sovereign debt crisis deepens. It sure won't be lifting them in a hurry.
If this sounds as if the banks have it all, there's just one snag. Raising money more cheaply is no help if they can't lend it. Lending is subdued because we're being more cautious.
Since the European debt crisis flared again, bank shares have been trashed. There has been talk of short selling by foreign investors who, all too familiar with sliding property prices in their home market, look at ours as a crash waiting to happen.
Moody's wouldn't have helped things, either, by downgrading their ratings. Is a downgrade of their earnings on the cards as well?
Maybe, but remember they don't have to do much at all and they would still report huge profits thanks to the large and mostly risk-free mortgages they have written.
Even the recent rise in the number of mortgages in arrears is tiny.
The banks are hanging out for a surge in mining-related business investment, which has been on the drawing board for some time.
Although they had hoped we would have seen some signs of it by now, it hasn't dented their optimism. But they might well be wary of lifting their dividends for the half-year, putting an end to the two years of increases since the slash and burn of the GFC.
Still, even without a rise in dividends, at current prices the banks are yielding between 5.9 per cent and 6.9 per cent.
After taking the 30 per cent tax credit from franking into account, that's a yield of 8.4 per cent to almost 10 per cent.


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