This is a guest post by Mr Credit Card from www.askmrcreditcard.com. Today Mr Credit Card is going to share with us what we can learn from the financial crisis in Greece, why we need to be very concerned about the state of our federal government finances and what we can learn as individuals. Please check out his best credit card offers page if you are looking for a new credit card
Greece has been in the headlines recently. The financial markets have been unsettled by what is going on there. But what is really going on and why we should all be concerned. Firstly, Greece admitted last year that their finances were not reported correctly and ever since they have been on a downward spiral. They have some really horrible statistics.
Greece has a budget deficit of about 13 percent of GDP. Their debt to GDP ratio is expected to increase from about 113 percent of GDP to about 121 percent of GDP this year. Their credit ratings have been cut by the rating agencies. The financial markets have lost confidence in Greece and they are now facing the following consequences.
Greece have seen their cost of borrowing rise. The credit default swaps market is pricing in a 55% probability of a Greek default. Greek banks have effectively been shut out of the interbank market. That means they do not have access to liquidity. Without access to liquidity, Greek banks cannot lend to businesses and credit has contracted massively. While the wealthy Greek business people probably have money outside of Greece. But the ordinary folks must be nervous about any potential run on the bank.
The Greek Parliament has just passed an “austerity” package – laden with budget cuts. There have been strikes by government workers who have the most to lose. They stand to face cuts in pension, cuts on salaries and jobs. To top it off, Greece does not really manufacturer any industrial goods anymore. Their economy is largely based on tourism.
Because Greece is part of the EU and its currency is actually the Euro, they cannot devalue their currency. Instead, Greece is likely to see deflation and a drastic drop in standard of living.
Why should the situation in Greece bother us? Isn’t Greece just a small country with just an 11 million population. But we should be concerned because to be honest, every developed nation has similar problems as Greece. Governments are running budget deficits.
If for whatever reason investors and folks lose confidence in the world’s financial system, then we could be in for a really rough ride. Here’s what we could potentially face here back home.
Higher interest rates – A loss of confidence could result in higher borrowing rates for government bonds. This could happen if the world loses confidence in our political will to cut spending and rein in entitlements. Higher interest rates mean higher mortgage rates. And higher mortgage rates mean lower house prices and more deflation (which actually may not be such a bad thing).
Higher Inflation – A loss of confidence in the US dollar would also lead to higher inflation. There will be deflation in the asset market, like stocks or housing and wages in general. But we will face imported inflation in energy prices, and higher prices from Walmart. Pensioners who rely on social security as their income source will face a lower standard of living because each dollar will buy less goods.
Lower Standard of Living – With deflation, lower wages and higher inflation, our standard of living will decline relative to where it has been. In fact, we are already seeing this in our very own states. How many of you are going to see state education budget cuts. Teachers will be fired and many programs for special needs children will face funding cuts. And I guess if you are working for the federal government, eventually, you will be facing cuts in your pension and higher retirement ages.
1. Spend less than you earn – This one seems so basic, but governments in most developed world violate this principle. So let me put this is BOLD – SPEND LESS THAN YOU EARN.
2. Always have an emergency fund – While Greece and other countries could be potentially “bailed out”, nobody is going to bail you out if you fall into financial difficulty. Greece did not have any “emergency funds”. Even if they did, the size of their deficits makes their situation unsustainable. We all need an emergency fund and not just the $1000 that Dave Ramsey suggests. We need more than that to tie us through months of no income.
Do not fill you life with unsustainable luxuries – Greece (as with most developed nations) have generous social safety nets that were unsustainable for their finances in the long run. Soaring pension plans and health care cost are simply unsustainable for a country with an aging population. There are some expenses in our household that fits this bill. Some are unavoidable like having to care for a special needs child or parent. But we may have many “luxury expenses” that cannot be sustained in the long run if our income takes a dip. Even the rich fall into this trap – living in too large a house (lots of property taxes to pay), having luxury boats. For us ordinary folks, it could be simply eating out too often, buying a larger house than you need.
Be competitive in your industry – One of the problems with Greece is that their cost structure has gone out of whack and they are no longer really competitive in any export market. Hence, they cannot even export their way of trouble. Here lies a lesson for us. Are you well known in your industry or your company? Are you adding value at all? If you get laid off, will other employers snap you up? To be able to bounce back from any financial setbacks, you have to maintain your ability to earn a good income.
Be willing to cut your living expenses – The reason nations like Greece and other developed nations find it so hard to cut their budget deficits is because their citizens do not have the will to live more frugally. There is a massive disconnect between what we want (welfare and medical benefits) and how much we are willing to pay (taxes). While countries can print money, we cannot. Hence, being willing to cut expenses and make some sacrifices is one of the very important traits we have to develop for ourselves.
Do not fall into the temptation of cheap debt – When Greece got accepted into the Euro, their cost of borrowing declined. And they went on a borrowing binge. We as individuals are also bombarded with such temptations. Zero percent down home financing (though those days are probably over), home equity line of credit, 0% for 24 months furniture deals, auto loan financing, 0% balance transfer credit cards and low interest credit cards make taking on debt a pretty tempting proposition. We have to be able to resist these temptations. A little debt does not harm. Paying 20% for your downpayment is good. Transferring a balance to another credit card to reduce debt is the smart thing to do. But when you start paying for a house you cannot afford, take out a home equity line of credit, and then finance all your other purchases with credit, then you will get into serious trouble.
Ending Thoughts – The situation in Greece (and in fact, the financial crisis) should serve as a reminder that we as individuals and as a nation have to live within our means, save and constantly be improving our skills to compete in a global market place. Fail to do any one of these, and trouble always looms ahead.
Related posts:
Nice post, Mike.
Have you read about Warren Mosler? In his eyes, debt, the deficit, etc… are simply “accounting tautologies” and are actually beneficial.
Yes, I suppose it is ‘beneficial’ to dump some 000s on another country and get real goods in return (Trade deficit), just the same as it is ‘beneficial’ to add a couple of 000s to some bank accounts in the system in order to magically pay off some bills.
However, how long will the fat lady sing? Greece’s voice has already croaked once. Whose will croak next?
Hi Kevin,
Yes, Mr, Credit put together a nice post! I am not familiar with Mosler. What I do believe is that a lot of people are delusional to think the West is immune from what happened in Greece. Greece needs to borrow from everyone to cover their budget deficits. For this, they are “scorned”. The US is doing the same thing when we sell our debt to China and Japan. We are entering the last stages of a major default, IMO. The amount of money in Govt Bonds is enormous and much of this could be wiped out at some point. When that happens it will be overnight, similar to how lenders and banks go away. Capital has been recognizing this for years and moving slowly into gold. If I mention gold (even today) people think I am nuts.
What is nuts is to think we can just keep borrowing and running up deficits without consequences. Politicians don’t listen. When you factor entitlements, we are around 850% Debt to GDP. Capital will seek the most liquid fiat currencies first. Then, when one of them defaults, gold will most likely be somewhere many thousands north of here. I wish this wasn’t the case but the mere fact that gold is rising against all fiat based currencies (along with the IMF’s recent action) tells me that’s where we’re headed. It will be interesting to witness.
Hey Mike,
Yep, nice post Mr. Credit! I guess my eyes glazed over the byline at the top! I don’t think you are crazy to be talking about gold; if you are crazy, then I guess I am as well.
However, the road to the end in the US is going to be long and hard. The US simply has far too much to lose by a change in the status quo. Give other countries some paper (or digital bits); receive real goods in return… a trade deficit works out pretty nice so long as you never have to pay back!
Regardless of the “accounting tautologies”, should other countries decide to stop shipping over real goods unless they get something other than paper or bits, there is going to be a long and hard fall in living standards, and it’s not going to be easy. I sure don’t doubt that SS will continue to get paid, that govt spending will continue, and that debt obligations will be met; the caveat is that, in relation to the prices of things, they will be met in devalued dollars. To be honest, my biggest fear is that a wave of populism rises up in response and heads down the wrong path. Certainly will be interesting times!
Mike
Populism has already risen. Look at how folks are pissed with Goldman Sachs even though unlike Lehman or Bear Stearns, they did not go bust! TARP jammed upon them by Fed! And most folks do not even understanding banking. They get their credit card limits reduced and they equate Chase credit card department with Wall Street! When Wall Street is really a phrase for the “I-bankers and traders”, not “commercial bankers!! (don’t believe me – ask any trader how they feel when a Wells Fargo loan office is equated with “wall street”!) Blame Goldman, when Goldman does not even issue credit cards. Blame them, but they do not even underwrite mortgages! Blame Blame Blame everyone but themselves!
In WW2, the people who were hated most were the black marketers. The folks who bought artworks at huge discounts. They were the Wall Street equivalent…
It happens in every crisis historically..ask the money changers in South America!
Mr. Credit, I am a pension consultant – at times I am seen as “Wall Street.” Go figure. Goldman is criticized by the government that won’t curtail it’s own spending. It’s madness. And you bring up a good point about blame. Goldman was not innocent; yet, they were essentially acting as a 3rd party “remitter” to the MBS market.
IMO, the injustice people see is that in their minds profits seem socialized while losses are nationalized. A Goldman Exec making tens of millions of dollars a year when people are fighting to stay above water. When Lloyd B uttered “We’re doing God’s work” people had it, IMO. Hence, Goldman as the last IB standing is the de facto target. We say the Fed is the “buyer of last resort” yet who really gets stuck holding the back time after time. Ultimately, an investor has to take responsibility.
Yeah – the term Wall Street is used loosely and inappropriately. Financial advisors from big bracket firms are considered “wall street” too – poor folks!
Most folks who are bitter and not financially well off will always blame someone else. How many folks can ever get to work for Goldman – probably not cos they did not bother to work hard for a 4.0 GPA! So what is there to bitch about!
Most folks can never earn the high six figures that google engineers make because they never bothered to study math and be good programmers!
Populism politics stifled Latin America for decades – oh well – history always repeats itself!
Nice post Mike,
I think so much boils down to common sense, which you articulated well in your post relating to Greece. It’s too bad it isn’t common. That said, we can only keep our own financial houses in order and control what we can control—and even then, there’s plenty we can’t control. Your steps, however, cover much of what we can monitor, relating to spending, having an emergency fund, cutting expenses etc. Benjamin Franklin would also have enjoyed this post. Spreading the word ensures that you’re contributing to living, as Charlie Munger would say, “A useful life”. Charlie is one of my heroes–however politically incorrect he can be at times.