Why Greek Austerity Does Not Equal Solvency

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My daughter is not Greek…but she sometimes acts like it. This observation is not meant to disparage my daughter…or the Greeks. It is simply an observation.

My daughter, Gaby, often makes promises, just before asking me for money. Yesterday evening, after she dirtied up a frying pan and a few kitchen utensils to make some pasta, I asked her to clean up the mess.

“Oh yeah, I’ll do that in a sec,” Gaby replied. “Can I have some money to go to dinner with my friends later?”

“Ah…I guess,” I stammered. “But make sure you do your dishes before you go.”

“Oh yeah, I will,” she smiled.

“Okay, here’s $20,” I said. “I’ll see you a little later. I’m going out for a bit.”

You all know what happened next…

Shortly after I left, Gaby skipped out the door with $20. The dirty dishes sat in the sink until I came home later…and cleaned them myself.

Jean-Claude Trichet, President of the European Union, are you listening?

Bad habits die hard. Gaby is too accustomed to making empty promises; her father is too inclined to believing them…and even to indulging them.

Christine Lagarde, Managing Director of the IMF, are you listening?

Yesterday, stock markets around the world rallied as the Greek parliament voted to accept the austerity measures that are a prerequisite for receiving additional bailouts from the European Union and IMF.

You see how easy that is? Make a promise; get some money.

Making promises is easy. Keeping them is the hard part. Within minutes of passing the austerity plan, riots broke out in Athens. “In a haze of tear gas,” the Associated Press reported, “protesters hurled anything they could find at riot police and tried to blockade the Parliament building… In Athens, the mood was dark.”

Nevertheless, the same AP news story related, “Investors cheered the bill – which aims to cut spending and raise taxes… The bill – along with another that must be passed Thursday on implementing the austerity package – will release the next Euro 12 billion (USD 17 billion) installment of a Euro 110 billion (USD 157 billion) international bailout from the European Union and the International Monetary Fund.”

We predict the Greeks (and Gaby) will continue making promises for as long as the promises yield handouts. But we also predict that the Greeks will stop making promises…and start breaking them as soon as the last check clears…if not sooner.

Promising austerity is not austerity, and even if it were, austerity is not solvency. The austerity plan the Greeks approved yesterday hopes to raise about $110 billion over five years. This sum would not even repay the $157 billion bailout the EU and IMF have provided already, let alone balance a budget.

For further perspective, $110 billion over five years would equal $22 billion per year (assuming my third grade math teacher was correct). That figure would not have come close to plugging Greece’s $34 billion shortfall last year or its $52 billion shortfall in 2009. And Greece’s near-term economic future is not looking any rosier than its recent past.

At the end of all this promising and indulging, we predict the Greeks will get the better end of the deal. They will trade feeble promises for hard dollars…until the hard dollars run out.

Already, each euro-zone household underwrites about 535 euros ($773) of Greek debt, according to Open Europe, a London-based research group. Already, almost none of these households wish to contribute a single euro to the “profligate Greeks,” much less 535 euros.

Presumably, these households will resist fresh capital calls from the EU. In other words, the money will run out and the Greeks will default.

Reprinted with permission from The Daily Reckoning.

Eric J. Fry has been a specialist in international equities since the early 1980s. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times, San Francisco Chronicle and Money. He appears regularly on business news stations like CNBC and Fox.

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