Greece: The Wile E. Coyote of Sovereign Debt

When it comes to Greece, really, it’s like this:

Wile E. Coyote

At this moment, there’s no telling what will happen to Wile E. and his Acme rocket. Maybe he’ll be shot off course, straight down into the canyon bed. Or the leather straps will break, and he’ll helplessly roll over the cliff’s edge. Most likely, the rocket will explode right where it rests, reducing Wile to a black stick figure of smoldering soot.

But two things are for sure:

1) The fuse is lit. There’s no turning back.
2) Wile E. won’t be catching Road Runner.

So goes the fate of Greece. With another credit downgrade from S&P yesterday, Greece’s debt status has been reduced to BBB “junk” and its Acme rocket fuse has been lit. No longer an “investment grade” debtor, the Greeks watched two-year bond rates spike another 500 basis points, to over 20%… a kiss of death from the bond market. For comparison, the yield on equivalent German paper is 0.8%. As the FT noted today, Greek two-year yields are now the highest in the world.

Though we’ve been suggesting it for some time, it’s now officially a question of not “if,” but “how” Greece will collapse. Either the EU/IMF bails ’em out or the Greeks default. We’d be surprised if the EU has the stones to put the euro through a sovereign default. At the same time, a bailout is going to be really expensive… Goldman Sachs estimated earlier this week the tab would exceed 150 billion euros.

Portugal and Spain had their credit ratings downgraded in the last 24 hours, too. As the Richebächer Society’s Rob Parenteau forecast here on Monday…this could end up being a far bigger mess than most people expect.

Traders seem to agree: The chaos in Europe pushed the S&P 500 down 2.3% yesterday.

“A great whirlpool of uncertainty now begins to swirl over who is going to pay for what, or whether it can be paid for at all,” notes our colleague Dan Denning. “That is not good for investors in the short term. But there IS one way in which it’s useful. It’s preview.

“That is, the Greek problem is also a euro problem. And the euro problem is a paper-money-backed-by-nothing problem coupled with high levels of debt. The only resolution to such a sovereign debt crisis is default or inflation. Because it does not control its own interest rates or money printing (monetary policy), the Greek government is at the mercy of the European Central Bank. And being genetically descended from Germany’s Bundesbank, the ECB is not willing to print euros in order to save Greece. Default remains.

“The Federal Reserve, of course, CAN print as much as it would like. And this is why we firmly believe the resolution of America’s own sovereign debt problem will be inflation. That’s the investment scenario we’re preparing for… A world awash in increasingly worthless paper claims on the full faith and credit of the United States government. But in the interim, the dollar is getting the 2008-like ‘flight to safety and liquidity’ bid.”

Ian Mathias
for The Daily Reckoning