Portugal, Italy, Greece and Spain (PIGS): Cracks in the European Union

The recent earthshaking announcement from Dubai World indicates that the U.S. is not alone in dealing with an overleveraged economy. In fact, many countries are in more dire straits than the U.S. As with real earthquakes, the financial aftershocks of Dubai World’s semi-default will be felt far and wide, particularly farther to the north in Europe. (Be sure to read our Special Section on Dubai, p. 34.)

Some of the weakest European countries have their own acronym, which runs counter to the positive overtone of the BRIC economies (Brazil, Russia, India and China). They are collectively called the PIGS (Portugal, Italy, Greece and Spain). Each of these economies has problems, but none more so than Greece. It has the least-loved bond market in the EU, as evidenced by its having to offer the highest interest rates. It also has the lowest bond rating in the union and the highest debt-to-GDP ratio at over 91%.

Many of Greece’s problems stem from problem banks. Greek banks poured money into the capital-starved Balkans to take advantage of the higher earnings potential. However, now that the Balkan economies have stopped growing, the potential for losses is staggering: Banks have extended loans to the region equal to 20% of Greece’s GDP. So, in 2008, Greece followed virtually every other nation as it bailed out its banks that weren’t smart enough to see a recession coming.

The Greek bank bailout cost 28 billion euros, which is equal to 10% of Greece’s GDP. Was it enough to prevent further bank problems? The President of the National Bank of Greece thinks so, as he recently stated that the naysayers are wrong and that the “rumors [of default] are exaggerated.” It reminds us of Bear Stearns CEO’s comment, “There is absolutely no truth to the rumors of liquidity problems,’’ six days before Bear Stearns was acquired before it had to declare bankruptcy.

Further problems are on the horizon for Greece with its budget deficit projected at 12.7% of GDP this year (4 times the EU limit). Greek businesses are hurting from a stronger euro, which has crimped tourism. Construction and shipping, of which Greece claims 20% of the world’s fleet, have also been slow due to the global recession. Add to these problems the fact that Greece needs $75 billion this year to meet expenses and for debt repayments. This leaves higher taxes and loans from the IMF or EU as the only likely stopgaps.

Both the stock and bond markets in Greece suggest economic weakness is dead ahead. The Greek stock market has rallied in corrective three waves with two equal legs up from its March low. And it’s already fallen 25% from its October 15th high. Investors in the Greek bond market demand almost 2% more from Greece than they do from Germany on a 10-year bond; investors see a fracture in the EU. The EU has stated that it won’t let Greece default, but it’s clear that investors have concerns.

U.S. investors should remember that Greece is simply one nation of many that are likely to produce further shocks to the global economy. Therefore, capital safety still seems to be the best option for most investors, while speculators may want to focus on the PIGS, and Greece specifically, for downside opportunities.

source HERE