It's always the little things, isn't it? Although Greece represents only about 2% of the EU's GDP, fears that the country's profligate spending will lead to the demise of Europe's economic alliance and its currency, the euro, have turned the financial world's attention (mine too, I'm a sheep) to this Mediterranean country of 11 million.
Wrong kind of attention
This fear has crushed the Greek stock market, which is down 33% since October, compared with a 4% increase for the MSCI EAFE. It's also sent the euro plunging 9% against the dollar over the same period. A weaker currency could be considered good news for some of Europe's economies, since it makes their exports more competitive in global markets.
However, it is bad news for companies like ABB
Joy spawns joy, fear begets fear
Although equity markets are generally efficient, they are still affected by the emotions of their participants, so they can easily become feedback loops. When investors believe a great story (the Internet in the late '90s, or risk management via securitization in the late '00s) they can believe asset valuations above any fundamental reasoning. They buy in, and when prices rise, they pat themselves on the back and buy more, pushing prices higher. Ultimately, someone or something breaks the cycle and the bubble pops.
On the down side, the same thing happens. Investors get scared and sell, which causes prices to drop, confirming the fears and leading to further selling. However, when the worst-case scenario doesn't come to pass, the market can rapidly snap back.
We saw this in early 2009 when we faced financial apocalypse. When the earth didn't open and swallow us whole, the markets rebounded, sending Bank of America
Greek tragedy
Now, financial minds around the world are predicting that Greece will implode economically. It's easy to believe this story. The government owes 113% of GDP, with $23 billion maturing before the end of May. The latest effort to refinance its debt required an interest rate of 6.37%, more than 3% higher than the rate on German government bonds (Europe's version of the risk-free rate).
At that level of interest, the Greek government would soon be overwhelmed just trying to pay its interest requirements. To appease the gods, er, markets, the current administration has proposed an austerity plan that is expected to reduce the deficit from 12.7% to 8.7% in 2010 and below 3% (and back in line with EU standards) by 2012.
This will require a combination of raising revenue and cutting spending by almost $14 billion this year, and more than $33 billion over the next three years.
Herculean task
That means persuading the Greek populace to accept higher taxes and Greece's army of civil servants to accept pay cuts and a restructuring of their pensions. This is a tough assignment in any country with an elected government, but Greece is particularly prone to protests and riots when the populace disagrees with their representatives.
However, there is evidence that this can be done. Ireland instituted harsh budgetary reductions last fall, as did several Eastern European countries like Hungary and Latvia. While Greece has seen several protests against the tax raises since the announcement of the austerity program, they have been relatively peaceful. It appears the Greeks understand their country is in dire straits and there are no easy outs. It also helps that the current administration has good relationships with the country's unions.
What they want to hear
Additionally, it may be that Greece doesn't actually have to achieve the $33 billion in budgetary restraint by 2012 to survive this. If the markets are pleased by the sacrificial ceremony, and see incremental progress in budgetary restraint, they may have mercy and allow Greece to roll over its debt at less-than-fatal interest rates.
If this comes to pass, the Greek market may be offering the once-in-a-lifetime deals we saw in early 2009. That's what Motley Fool analysts Tim Hanson, Joe Magyer, and I are in Athens attempting to figure out.
You can follow us in real time at www.foolgreece2010.com. To get our dispatches from the ground, as well as our report on the best way to invest in the Greek chaos, enter your email address in the box below.
