You might have heard something about Greece in the news recently and wondered what all the fuss is about. After all, why does it matter to Australian investors if Greece leaves the Eurozone?
Apart from the obvious impact on stock markets, which hate uncertainty whether it's US Debt, Greece, falling oil and commodity prices, Russia invading Ukraine, there's always something making the markets nervous.
Over the weekend, negotiations between Greece and its creditors broke down for what seems the umpteenth time. Cash is flooding out of the country and Greece's banks at a record pace – with many investors wanting to get their Euros out before the country locks down its banking system – which it has now done.
Greece has closed its banks and stock market today and placed restrictions on the withdrawal and transfer of money, in an effort to shore up its financial system. The banks are expected to stay closed for at least this week.
Debt and taxes
The problem for Greece is that the country has borrowed heavily and without the support of its lenders, is struggling to make interest and debt payments. A fly in the ointment is that Greece's government has decided to put its fate in the hands of the people, asking them to vote on the latest creditor's offer next Sunday – but the current bailout program ends on Tuesday when Greece is due to pay back €1.6 billion to the International Monetary Fund (IMF).
Essentially the problem is that European lenders, including governments, want Greece to cut back on its government spending – in other words, to impose 'austerity measures' – in return for lenders continuing to support the country. It's a bit like a bank telling a customer that unless they cut back on their credit card spending, the bank will be forced to lower the credit card limit and demand repayment of any outstanding monies.
The system is broke
One Greek newspaper conducted a poll of 1,000 people asking them which way they would vote. 57% of them say they would prefer a deal that keeps Greece in the Eurozone, suggesting the literal can will continue to be kicked down the road. If Greeks vote that way, then the government will need to cut back spending and sort out its apparent mess of a tax system. To give you an example, like our GST, Greece has Value Added Tax or VAT. But Greece has six different rates according to the UK's BBC.
The pension system was likewise complicated with numerous exceptions for different jobs allowing for early retirement. The most-often quoted example is that of hairdressers because their work is deemed unhealthy, allowing them to retire at age 50, along with bakers, pastry chefs, masseurs and trombonists. That appears to be changing, with Greece no longer rated the weakest in the world, but the country still spends 17.5% of its GDP on pensions – higher than any other country in the European Union (EU).
Consequences
So lenders want Greece to raise taxes, reduce government pension spending and sell off assets, such as the Port of Piraeus, but the Greek government fears that doing that could cripple a country that is already seeing unemployment levels of 26%. Greek youth unemployment is reportedly over 50%. Consider that for a moment and compare that to Australia's 6%. Austerity measures imposed since 2010 have seen Greece's GDP fall 25%, so clearly that's not working. Harsher measures could have even more drastic consequences with a worst case scenario being total anarchy.
The other side of the coin is equally unattractive. Should Greece default, the country will return to its previous currency, the Drachma. While that might solve some problems, it raises others with expectations that Greek companies would close and unemployment rise. International investment in the country would also collapse.
Other countries facing similar problems could follow suit and default. Lenders, such as the IMF, which has already lent Greek banks a reported €118 billion and a further €20 billion in buying government bonds, would face huge losses. Greece owes its lenders €320 billion in total, according to the BBC, ensuring a default would have widespread aftershocks. The consequences of that are unknown – but clearly have major implications for stock markets, including our own ASX.
Foolish takeaway
The essential problem is that the Euro currency is shared among many countries with differing economic profiles. Some have strong economies, while others like Greece have economies that are unsustainable. The country doesn't collect enough tax, nor generate enough revenue to support itself. Until that is fixed, Greece relies on the good favour of its lenders, and that appears to have run out.
