When Economies Collapse

June 16, 2010 by Joe Ponzio

How will the historians call this one? The European Crisis? Euro-doom? If you’ve been under a rock for the past few months, you may not have noticed the recent downturn in the markets. The headlines are all about the potential default of Greece on its debt, possibly followed in short order by a slew of other EU counties — Spain, Portugal, Ireland and Italy top the list.

Naturally, I have received a few e-mails and phone calls on this one; so, let’s talk about what happens if/when one or some of these countries go down for the count.

Putting It Into Perspective

Before we get all hot and bothered by a Greek default, let’s look at the difference between a country’s default and the sub-prime crisis. Why, you ask? Because of comments like this from one trader:

This is similar to what took place pre-Lehman Brothers.


When a large amount of homeowners take out mortgages they can’t afford, and the values of their homes drop, they leave the banks holding the bag. A $500,000 mortgage on a $300,000 house is, essentially, worthless to a bank. Sure, it can recover a portion of the money it lent, but $0.60 on the dollar is a huge blow. Do that to the bank a few million times over the course of two or three years, and…voila! You have a banking crisis!

When a country “defaults” on its debt, it typically does not walk away, sending the keys to its foreign bond holders. Instead, the country restructures – slashing its budgets, cutting spending, and perhaps seeing some of its debt “forgiven” by bond holders…in exchange for a higher interest rate on the lower amount. That debt doesn’t go to zero or even $0.60 on the dollar (usually). It gets restructured, perhaps cut a bit, and then worked out over longer periods of time.

Though these are very rough calculations, you get the point — the sub-prime crisis was much larger than the Greek debt crisis. And, they are totally different. Investors are incentivized to buy Greek debt at a discount as they may earn capital gains and interest on their bonds. (A default would not normally stop interest payments altogether. It would instead cause existing debt to be refinanced.)

Investors in sub-prime loans after 2007 would earn no interest (if the loan defaulted), and could only make money from gains. As such, the loans would have to be sold for less than $0.60 on the dollar if the bank didn’t want to hold the non-interest paying debt.

So…What If Greece Defaults?

But it’s still a problem if Greece defaults, right? Not really. And to put that into perspective, let’s use common sense backed by some statistics and history. First, the common sense – and no offense to our readers in Greece, but…what the heck is in Greece from a global economic standpoint? Nothing!

Greece exports a little, but to Italy and Germany (mainly, about 11%), and to Bulgaria, Cyprus, the US (5%), the UK (5%) and Romania. They import a little as well. How “little” you ask? The entire economy of Greece is $331 billion — about 2.3% the size of that of the US. In short, if Greece fell off the face of the Earth economically, we would barely notice.

But It’s The Whole Eurozone!

Let’s say they haven’t contained the crisis — that, along with Greece, Spain, Portugal, Ireland, and Italy all default on their debt. In fact, they all collapse economically. What’s the damage? With GDPs respectively of $1.4 trillion and $2.1 trillion, Spain and Italy are the two “big” elephants in the room. The GDPs of Portugal and Ireland are each about $228 billion. You know…just shy of Apple’s (AAPL) market cap as of yesterday’s close.

First, let’s be realists — the odds of all five countries experiencing a total economic collapse to zero are practically nil. They all need to get spending and debt under control. Maybe they all need to restructure and refinance their debt. But they ain’t all going to zero.

Now, let’s amuse ourselves. What if their combined economies — coming in at 31% of US GDP — all collapsed entirely. What if they all went to zero…

The World’s Second Largest Economy Just Collapsed? Big Deal.

Before its dissolution, the USSR’s economy was second only to that of the United States. In 1989, the GDP of the USSR was $2.7 trillion — about 49% of US GDP ($5.5 trillion). And if you think that Greece’s finances are screwed up, you should see what the USSR looked like before it collapsed! Out-of-control government spending to prop up failed enterprises and fund military expansion and cold wars, all while subsidizing consumers.

In 1991, the Soviet Union was dissolved. The currency was wiped out. Debt defaulted. Civil unrest. Cats and dogs living together. You get the idea.

The Soviet Union essentially went to zero. And how did our markets respond?

Is This a Crisis or an Opportunity?

Some will say that I’m oversimplifying things. I’d argue that they’re overcomplicating things. Image what the news was like from 1989 through 1993, just before, during, and after the collapse of the Soviet Union. Did the media keep a cool head? Did reporters brush it off, seeing clearly into the future that the collapse of the world’s second largest economy was nothing compared to the potential 2010 debt restructuring of Greece’s tiny economy?

Let’s rely on common sense. We’ve survived two world wars, a depression, dozens of recessions, a cold war, and more, including the creation of the Euro. And this is what we’re worried about?

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