Greek Debt Failure Is A European Risk

By Scott Carter, CEO, Goldline International
October 12, 2011

Europe continues to fight the threat of debt contagion as Greece warns that it will miss its deficit targets for this year.  German Chancellor Angela Merkel and French President Nicolas Sarkozy have pledged to unveil a new plan to combat the region’s debilitating debt crisis and help recapitalize banks by the end of October, but investors still remain wary.

Greece’s deficit targets were set in July as part of a comprehensive financial bailout package.  As a condition to the bailout, Greece agreed to reduce its budget by 30 billion euros.

Although the country enacted a controversial budget to slash thousands of public-sector jobs, European finance minister Jean-Claude Juncker announced the Euro Group would delay its next aid payment to Greece so its inspectors could continue evaluating Greece’s financial health.  This announcement roiled stock markets recently as investors fled equities amid concern that the debt crisis would spread to other nations.

In May 2010, global policymakers created an emergency safety net of approximately $1 trillion to bolster financial markets and prevent the Greek crisis from damaging the euro.  The package was comprised of 440 billion euros in guarantees from euro zone states, plus 60 billion euros in European debt instruments.  EU finance ministers said the IMF would contribute a further 250 billion euros to the fund.

In July, EU leaders agreed to increase the fund by an additional 109 billion euros with investors swapping some of their Greek bonds for loans for bonds with longer maturities and European guarantees.  The EU leaders have since debated the best course of action to combat the Greek debt crisis.  In September, European officials angrily stormed out of meetings in Athens, saying that Greece was failing to live up to austerity promises.

The so-called PIGS (Portugal, Italy, Greece and Spain) are so overburdened with debt as to threaten the fiscal stability of the entire Eurozone.  Three of these countries have debt which exceeds their GDP.  Only Spain has a debt-to-GDP ratio below 100% even though this country currently has 20% unemployment.  Italy, which has the third largest economy in Europe, has a debt-to-GDP ratio is 120%.

Banks in both France and Germany, hold a great deal of the PIGS’s sovereign debt and, as such, are at risk of failing if the countries default on their debt.  Overall, the banks in Europe are experiencing a crisis similar to what the United States saw after the Lehman collapse.   As a result, France and Germany are working on a plan to recapitalize financial institutions in Europe.

Goldman Sachs is now forecasting that the euro zone will slip into a “mild recession” in the fourth quarter of 2011 and first quarter of 2012.  The firm cut its gross domestic product outlook for advanced economies for 2012, lowering its growth forecast to 1.3 percent from 2.1 percent, saying “the main driver of our shift in views has been the escalation of bank funding stress in the Euro area, alongside deeper public budget cuts in a number of European countries.”

With equity markets selling off strongly on news of a worsening situation in Greece, several analysts expect gold to separate from the recent flight from risk and liquidation of stronger-performing assets.   “After the recent washout, gold positioning is far from extended and this is quite a bullish signal for price strength ahead, said UBS analyst Edel Tully.  The ‘clean’ nature of current [speculative] positions, along with physical and long-term demand, is creating a very healthy foundation for gold to climb from,” the bank said.

Commenting on gold, Simon Denham, CEO of Capital Spreads, said “investors were seen to still be considering the precious metal a safety haven and buying in to protect themselves from the market limbo caused by a looming Greek default.”  Price moves higher, which have not been hampered by a strengthening dollar, may indicate “the resumption of a new rally after the recent correction.”

Societe Generale said it remains broadly bullish on the outlook for gold and now expects the 2012 gold price to average $2,175 per ounce. The precious metal has averaged approximately $1,540 an ounce so far this year.

(Source: Source: “Gold strengthens as Greek fears worsen,” MarketWatch, October 4, 2011 “S&P enters bear market, Greece Sinks Wall Street,” Reuters, October 4, 2011; “Wall Street set to open in bear market,” Reuters, October 4, 2011; “Gold turns lower as wider markets slide,” Reuters, October 4, 2011; “PRECIOUS-Gold rises 1 pct on fears of Greek default,” Reuters, October 4, 2011; “Spot Gold Gains On Euro Debt Fears,” Wall Street Journal, October 3, 2011; “PRECIOUS-Gold rises for third day after Greece rocks markets,” Reuters, October 3, 2011; “PRECIOUS-Gold extends gains, equities drop on Europe debt fears,” Reuters, October 3, 2011; “Greece,” New York Times, September 27, 2011; “European Financial Stability Facility Expansion Could Stop Contagion, If Voters Approve,” 247WallStreet.com, September 23, 2011; “Euro Zone Debt is a Greek Tragedy,” AmericanAdvisor.com, June 2, 2011)

Scott Carter is Chief Executive Officer of Goldline International, Inc.