John Freeme explains the impact of the Greek debt crisis.
You’re a parent of five. Unfortunately, none of your children are very good with their finances: they all spend more than they earn, don’t sweat the small amounts and don’t chase people for any money owed to them.
When you ask them how they’re coping financially, they always answer, 'Fine'.
Then, one day your eldest son, Greece, comes to you and says he’s just received a call from his bank. He’s spent all his credit cards to their maximum and has reached his overdraft limit. He has no money for rent and risks being evicted if he doesn’t pay next month’s rent instalment.
You sit him down and give him a stern lecture on spending, the importance of budgeting and suggest you and his mother may be in a position to lend him some money.
Knowing his current lifestyle and the amount of monthly interest on his existing debts, you’re unsure if you should lend him the money to help straighten out his finances. To add insult to injury, whilst you’re considering helping your eldest son, you begin to notice some of your other children (Portugal, Spain, Italy and Ireland) also showing signs of overspending.
What to do?
The debt crisis across Europe has continued to gather momentum throughout April and as the market has continued to soar, so has the cost of debt available to those countries which are running massive deficits. This has forced Greece and potentially Portugal to consider other avenues of sourcing cash.
The EU and International Monetary Fund (IMF) have committed ‘in principle’ to helping Greece who have now officially asked for help. The ‘in principle’ bail-out involves the EU contributing €30bln and the IMF a further €15bln.
Objections from some of the EU member countries have, however, continued to hamper the ‘in principle’ package being rolled out. Germany in particular has been hesitant in actually transferring the funds they have agreed to contribute. Germany’s Chancellor, Angela Merkel herself has recently said they will only join the rescue, if Athens makes budget cuts lasting several years.
However, it does look likely that a decision is imminent, with the Euro zone leaders calling an emergency meeting on the 10 May in which they hope to approve the bail-out of Greece. Should Greece not receive EU/IMF funding, it will default on its existing debt on 19 May.
What wider affects has this had?
Greek debt concerns and constant downgrading of their debt rating by the majority of ratings agencies have driven Sterling from 1.0945 on 9 March 2010 to 1.1620 on 23 April, as investors move out of the Euro. Meanwhile, EUR/USD has been no different, plummeting from 1.3817 on 17 March 2010 to 1.3127 on Wednesday. This constitutes a saving of €3,375 on a £50k transaction to Euros in a matter of just 8 weeks and if you were to move $50k to Euros, a saving of €1,900 in roughly the same period.
Meanwhile, volatility on an intra-day basis has also been higher than normal with a movement of 1.5% to 2% daily seen regularly over the course of the bail-out negotiations.
Returning to the analogy above, if you’ve ‘maxed’ all your credit cards and have reached your overdraft limit, the issue is not only paying that capital back, but also the interest charges accruing on the amounts already owed. Is taking on more debt at inflated interest rates going to help? In the short term, yes, but in the long term, isn’t it just going to add more to the total debt pool and in six months time you need bailing-out again? Therefore, the only long term solution would to be get a better paid job to cover the lavish lifestyle you are accustomed to or go for debt counselling and learn to live within the means your current income allows.
Relating this back to Greece, the only way they can ‘get a better paid job’ is if they see their income as a country increase and with their latest quarterly GDP figure at 0.08% (still officially in recession) this looks like a long-shot. So, Greek budget cuts are essential and by the looks of it will be demanded by the EU members contributing the funds to ensure that this is not just a short term patch up job, but a total change in ‘lifestyle’.
‘Debt counselling’ and being more frugal will include addressing many existing extravagant spending practices in Greece, such as 14 pension payments a year (monthly and extra payments at Easter and Christmas) not contributing to health care and social costs and stopping pension payouts of €3,500 a month, for example, for a retired postman.
As ‘Bank of Mum and Dad,’ when your second child (Portugal) starts looking like it’s going down the same slippery slope, what should you do? You may be able to help one or two of your children, but can you afford to help them all?
Currently, Portugal is also harbouring a major deficit. Their last reported GDP figure was a negative 0.2% and their cost of borrowing has soared to over 5%. The EU will not have enough money to bail-out all of the ‘PIIGS’ (Portugal, Italy, Ireland, Greece and Spain), with countries like Spain, should they need bailing out, requiring much larger amounts as there economy and therefore deficit by value is far greater than Greece.
And so, ‘Bank of mum and Dad’ (EU) has a very difficult decision to make. They know their children desperately need cash and can’t bare to see them sleeping on the streets, but also they are acutely aware that their eldest son, Greece, may not be able to pay back the loaned money. By helping one child, they are setting a dangerous precedent for those other children who may also need their parents’ financial help. Surely you can’t help one child and not the rest?
The key question then is – can you afford to help all your children without bankrupting the entire family?