The Greek Drama Continues

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How Europe’s Systemic Failure Will Impact the Globe

An exclusive from Phoenix Capital Research: The Greek drama continues.

The process thus far has been along the following lines:

  1. Greek Prime Minister Alexis Tsipras states publicly that he is confident that a deal will be met because Greece is willing to compromise.
  2. Tsipras then refuses to compromise behind closed doors with EU officials.
  3. Tsipras tells the media and Greek citizenry that the EU is evil and is attempting to enslave Greece.

This process has been maintained for over five years now. This only further illustrates one of my central themes: everything in Europe is about politics.

Europe as a whole is socialist in nature. You will never hear a discussion of “how involved should the Government be in the economy?” in most of Europe; it is just assumed that the Government should always be involved a large degree.

The question is whether it should be a lot (the public sector accounts for 30% of jobs in Germany) or almost entirely (the public sector accounts for 56% of jobs in France).

When more than one in three people are employed by the public sector in one form or another, everything is driven by politics.

The best example of this, of course, is Greece.

Greece has been and remains a fiscal basket-case for three simple reasons:

  1. The Government attempts to employ as many people as possible even if it makes absolutely no sense to expand the Government workforce.
  2. The Government pays WAY above what the work requires (on average public sector wages are 150% of private sector wages and most employees receive pensions equal to 92% of their salary at retirement).
  3. Greek culture not only embraces, but celebrates tax evasion (so there is little Government revenue to finance all those overpaid bureaucrats).

The level of fiscal insanity goes above and beyond anything you’re likely to see.

Consider the Greek metro system. It takes in €80 million in annual ticket sales… and spends over €500 million in salaries.

There is a word for an entity that spends over SIX times its annual revenues on employee salaries… it’s bankrupt.

This sort of scam is endemic in Greece. Anyone from pastry chefs to hairdressers and other services-based sectors can retire at age 50 and receive a pension equal to 95% of their salary.

Suffice to say, the Government payouts are extreme.

Unfortunately, Greek taxpayers don’t want to fund it. Greece has a population of 12 million. Less than 5,000 of these individuals report taxable income of more than €90,000.

Put it this way, less than 0.01% of the Greek population claims they make more than €90,000 per year in salary. This for a country that has over 60,000 individuals with investments of over €1 million… and those area simply the individuals willing to admit it!

The effort that goes into this subterfuge is staggering. In 2010, the Greek tax authorities began using satellite imagery to target Athens homes with swimming pools (a sign of wealth). Only 324 Greeks claim to have such homes in Athens. The satellite study found nearly 17,000 homes with pools before an enterprising Greek began selling pool covers that look like a normal lawn.

Simply put, in Greece we have a bloated bureaucracy that pays exorbitant salaries and pensions in a culture that goes to great lengths to hide its wealth/pay taxes.

Greece however is not the REAL issue for Europe. The REAL issue concerns the derivatives trades that are backed by Greek debt.

Modern financial theory dictates that sovereign bonds are the most “risk free” assets in the financial system (equity, municipal bond, corporate bonds, and the like are all below sovereign bonds in terms of risk profile). The reason for this is because it is far more likely for a company to go belly up than a country.

Because of this, the entire Western financial system has sovereign bonds (US Treasuries, German Bunds, Japanese sovereign bonds, etc.) as the senior most asset pledged as collateral for hundreds of trillions of Dollars’ worth of trades.

The global derivatives market is roughly $700 trillion in size. That’s over TEN TIMES the world’s GDP. And sovereign bonds… including even bonds from bankrupt countries such as Greece… are one of, if not the primary collateral underlying all of these trades.

Greece is not the real issue for Europe. The entire Greek debt market is about €345 billion in size. So we’re not talking about a massive amount of collateral… though the turmoil this country has caused in the last three years gives a sense of the importance of the issue.

Spain, by comparison has over €1.0 trillion in debt outstanding… and Italy has €2.6 trillion. These bonds are backstopping tens of trillions of Euros’ worth of derivatives trades. A haircut on them would trigger systemic failure in Europe.

In short, the EU’s worst nightmare is a debt haircut or debt forgiveness for Greece because it opens the door to Spain or Italy asking for similar deals down the road.

And that’s when you’re talking about REAL systemic risk.

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