If PIIGS Could Fly


By John Nicola, CFP, CLU, CHFC

The Swine Flu pandemic may have come and gone, but PIIGS will need to fly if we are to survive the latest financial crisis.

For those of you who have not heard the acronym, PIIGS stands for five European countries that are also in the Eurozone (Portugal, Ireland, Italy, Greece and Spain). All of them are fiscally challenged, but none more than Greece.

It just might be the proverbial “canary in the coal mine,” but on the other hand, why does it matter if one of the smallest countries in the Eurozone defaults? It would be like Rhode Island going into Chapter 11: inconvenient for some but, a fresh start for Rhode Islanders.

Truth be told, the fate of Greece may be the first signpost indicating our economic direction for the next decade, and understanding their situation will be key to shaping investment strategies.

Unfortunately, the implications of a sovereign default are (in our opinion) quite significant and nations around the world may be watching another cautionary tale unfold. Ever-increasing national debt, an inability to control government spending, and a quickly-fading naïveté about their circumstances that exacerbates the problem: it’s a familiar story that strikes too close to home for many developed countries. The world is staring at Greece from the corner of its eye (just as it did with Dubai before) wondering, “Who’s next?”

We usually reserve the idea of sovereign defaults to South American, ex-Soviet Union and African countries run by sociopathic totalitarian dictators who keep most of their money in Swiss banks. The actual history of countries reneging on their financial obligations tells a far different story.

Greece is but the latest in a long line of serial defaulters over just the last 200 years. In their brilliant book This Time it’s Different (Eight Centuries of Financial Folly), Carmen Reinhardt and Kenneth Rogoff detail the myriad of national defaults, their causes and their outcomes.

Specifically, they point out that Greece (the cradle of democracy and the birthplace of legends) has been in default for 105 years of its 200-year existence as a democratic nation. (I wonder what the Greek word for “Ponzi” is?) In fact, they document 66 countries between 1800 and 2009 representing 90% of the global economy and only 17 of them have not defaulted on their debt at least once.

Among the ne’er do wells:

  • France
  • Germany
  • China
  • Russia
  • Italy
  • Spain
  • India
  • Japan
  • Every African country except Mauritius
  • Every Latin American country

Interesting to note that Canada, along with Australia, New Zealand and the U.S. are “default virgins.” That list also includes most of the Scandinavian countries and a few of the Asian Tigers (Taiwan, Korea, Hong Kong, Malaysia, Thailand and Singapore), although some of these countries required the IMF to bail them out during the Asian Crisis of 1997. Overall, a pretty short list of countries.

But surely things are different now? Not likely, according to Reinhardt and Rogoff. We are just going through the toughest economic environment since the 1930s, and as a result of that, most countries have put their printing presses into overdrive to accomplish one or all of the following:

  1. Bail out or recapitalize banks and insurers.
  2. Provide fiscal stimulus in order to counteract the effects of increases in unemployment.
  3. Guarantee or subsidize housing or mortgages to reduce the rates of defaults.
  4. Have central banks buy government bonds, because in addition to all of this spending, tax revenue is down and the cupboard is bare.

If this was a normal crisis, it would likely play itself out. Eventually, government stimulus would stop and both interest rates and taxes would rise in due course as businesses recovered and unemployment started to fall. But all governments (both developing and developed) have other liabilities that are coming home to roost.

The world is aging, and based on UN projections, global population will likely peak around 9 billion somewhere around the middle of the 21st century and then start a slow decline from there. Given our need to manage our resources better, this should be seen as good news – and it is. But in order for this to occur, birth rates must continue to fall and, consequently, the average age of populations around the world will increase. Over time, this will increase liabilities in areas such as pensions and health care. This is already a huge issue with developed countries and will only get worse.

The following charts from The Economist tell a compelling story.

So let’s get back to Greece. First, by way of background, I would recommend two recent articles about the current and longer-term impacts of Greek debt (and, by implication, the worsening fiscal picture of their fellow PIIGS- Portugal, Ireland, Italy and Spain):

Greece has a current debt to GDP ratio of 110% (in Canada we are about 75% including all provinces). This year they will run a fiscal deficit of 12.7% of GDP (the Euro area maximum is supposed to be 3%). While it is true the US and the UK are also at those levels, they have more borrowing power and less current debt relative to Greece (our own annual deficit needs this year look to be in the range of about 6% of GDP including the provinces).

Greece also has 30% of its economy underground and the government spends 50% of national income. (I know we think we are hard done by, but in Canada, all levels of government spending only accounts for 38% of national income.) To emphasize how prevalent the Greek “national sport” of tax evasion is, only six Greeks admitted to earning an income of more than €1-million.

Basically, Greece is broke and the fallout will depend on how the stronger Eurozone members deal with their weaker partner and how they deal with the rest of the iceberg (the other PIIGS).

There are a few points I would like to make here:

  • Greece is just one example of how even sovereign nations can hit the debt wall hard. There will be more to come.
  • Reinhardt and Rogoff’s book suggests that if countries make the hard choices to get their debts under control and do not default (or try and inflate away their debt), then the outcome is almost always a very long, tough and extensive climb out of that debt – a process which surely results in either deflationary or disinflationary pressure. Governments cut back services and may increase taxes, which will reduce overall spending. Perhaps the best long-term medicine, but painful nonetheless.
  • If our current fiscal mess is causing all of this grief, how will we ever fund the pension and health care promises we (as with many other countries) have made? In my opinion, the short answer is: we will not be able to fund these promises and they will change because they cannot be afforded. If we want to live well during retirement and have access to the best health care, then we will be relying even less on government entitlements.
  • Countries are no different than individuals or companies; they cannot borrow their way to prosperity. To be fair, a certain level of debt does improve productivity and wealth, but it has to be well within the capabilities of the borrower. We are now fast approaching debt levels where there will be a point of no return.

Ironically, our ability to borrow safely is also a function of our overall wealth and productivity. Governments who want to borrow more would be wise to remember the source of their golden eggs.

As I mentioned earlier in this article, Greece’s situation may seem half a world away, but its outcome will unquestionably shift the global economic landscape and will ripple into your investments. In our upcoming Market Outlook seminar (March 15th in Vancouver and March 18th in Kelowna), we will examine the impact of debt, deflation and demographics on our investment approach in greater detail and explore how investment portfolios will take shape as we look ahead into the second decade of the 21st century.

By the way, there really is a poem called “If Pigs Could Fly,” written by James Reeves. The first three lines are:

If pigs could fly I’d fly a pig
To foreign countries small and big
To Italy and Spain…

Now if he had just thought to add Portugal, Ireland and Greece, he could have been both a poet and a seer.