Ambrose Evans-Pritchard at The Telegraph describes the overspending and debt problems in Greece. It could provide some insight into what happens when government bonds (debt) cannot find any buyers.

Link: Greece tests the limit of sovereign debt as it grinds towards slump

Greece is disturbingly close to a debt compound spiral. It is the first developed country on either side of the Atlantic to push unfunded welfare largesse to the limits of market tolerance.

Euro membership blocks every plausible way out of the crisis, other than EU beggary. This is what happens when a facile political elite signs up to a currency union for reasons of prestige or to snatch windfall gains without understanding the terms of its Faustian contract.

When the European Central Bank’s Jean-Claude Trichet said last week that certain sinners on the edges of the eurozone were “very close to losing their credibility”, everybody knew he meant Greece.

The interest spread between 10-year Greek bonds and German bunds has jumped to 178 basis points. Greek debt has decoupled from Italian debt. Athens can no longer hide behind others in EMU’s soft South.

“As far as the bond vigilantes are concerned, the Bat-Signal is up for Greece,” said Francesco Garzarelli in a Goldman Sachs client note, Tremors at the EMU Periphery.

The newly-elected Hellenic Socialists (PASOK) of George Papandreou confess that the budget deficit will be more than 12pc of GDP this year, four times the original claim of the last lot. After campaigning on extra spending, it will have to do the exact opposite. “We need to save the country from bankruptcy,” he said.

Good luck. Communist-led shipyard workers have already clashed violently with police. Some 200 anarchists were arrested in Athens last week after they torched streets of cars in a tear gas battle.

Mr Papandreou has mooted a pay freeze for state workers earning more than €2,000 a month. This has already set off an internal party revolt. “There is enormous denial,” said Lars Christensen, emerging markets chief at Danske Bank. “They don’t seem to understand that very serious austerity measures are needed. It is a striking contrast with Ireland,” he said.

Brussels says Greece’s public debt will rise from 99pc of GDP in 2008 to 135pc by 2011, without drastic cuts. Athens has been shortening debt maturities to trim costs, storing up a roll-over crisis next year. Some €18bn comes due in the second quarter of 2010 (IMF).

Modern economies have reached such debt levels before, and survived, but never in the circumstances facing Greece. “They can’t devalue: they can’t print money,” said Mr Christensen.

The tourist trade is withering, down 20pc last season by revenue. Turkey was up. It is hard to pin down how much is a currency effect, but clearly Greece has priced itself out of the Club Med market. Wages rose a staggering 12pc in the 2008-2009 pay-round alone (IMF data), suicidal in a Teutonic currency union. Greece has slipped to 71st in the competitiveness index of the World Economic Forum, behind Egypt and Botswana.

Greece has long been skating on thin ice. The current account deficit hit 14.5pc of GDP in 2008. External debt has reached 144p (IMF). Eurozone creditors – German banks – hold €200bn of Greek debt.

A warning from Bank of Greece that lenders must wean themselves off the ECB’s emergency funding has brought matters to a head. Default insurance on Greek debt jumped 40 basis points last week.

Greek banks have borrowed €40bn from the ECB at 1pc, playing the “yield curve” by purchasing state bonds. This EU subsidy has made up for losses on property, shipping, and Balkan woes.

The banks insist that they are in rude good health. EFG Eurobank has halved reliance on ECB funding. “Greek banks are very liquid: we maintain billions in extra liquidity,” it said. Yet markets are wary. Recession has come late to Greece, but will bite deep in 2010. It takes three years for defaults to peak once the cycle turns.

David Marsh, author of The Euro: The Politics of The New Global Currency, said the danger for EMU laggards is that the ECB will begin to tighten before they are out of trouble. It is German recovery that threatens to stretch the North-South divide towards breaking point.

Athens squandered its euro windfall. For a decade, EMU let Greece borrow at almost the same cost as Germany. It was a heaven-sent chance to whittle down debt. Instead, the country dug itself deeper into a hole by running budget deficits near 5pc of GDP at the top of the boom.

Like Labour under Brown, idiot leaders mistook a bubble for their own skill. But the consequences in EMU are more dreadful. Austerity may prove self-defeating, without the cure of devaluation. Greece risks grinding deeper into slump.

The EU can paper over this by transfering large sums of money to Greece. But will Berlin, Paris – and London, also on the hook – feel obliged to bail out a country that has so flagrantly violated the rules of the club, not least by holding Eastern Europe’s EU entry to ransom over Cyprus? That is neither forgotten, nor forgiven.

During the panic last February, German finance minister Peer Steinbruck promised to rescue any eurozone state in dire trouble. He is no longer in office. The pledge was, in any case, a bounced political cheque even when he wrote it. Greece can assume nothing.

via John Mauldin

John Mauldin told us the financial crisis was coming and why. Now he’s issuing a stern warning about the next phase of the financial crisis. Excerpts below.

I’m preparing for the worst and hoping for the best.

Link: Thoughts from the Frontline by John Mauldin

The Obama administration tells us that the government deficit is going to be well over $1 trillion a year for at least ten years. And that does not take into account the outlier years in the 2020s when the really heavy lifting of Social Security and Medicare kicks in.

There is a truism that goes a little like, “If something can’t happen, then it won’t.” Let me make a prediction. We won’t have a trillion-dollar deficit in ten years. Why? Because it can’t happen. The market will simply not allow it.

As I have written, we can run large deficits almost forever, as long as the deficits are less than nominal GDP. While it may not be the wise thing to do, it does not bring down the system.

But when you start adding to the deficit in amounts significantly larger than nominal GDP, there is a limit. Each dollar, like the grains of sand, adds to the potential instability of the system. Is it $2 trillion more? $3 trillion? No one can know, but the longer it goes, the worse the ensuing financial earthquake will be.

The current political class and their intentions are dangerously close to killing the golden goose. It is one thing to steal the eggs; it is an altogether different thing to kill the goose through ignorance of the consequences. And the size of the deficit, for as long as they plan to have it, will most assuredly kill the goose.

Just as I was writing in 2006 about the potential for a crisis, and yet the party went on for quite some time, I think the party can limp along now. But there will come a point when the party is over. Interest rates on the long end will rise precipitously, forcing mortgages up and making the deficit even worse. It will be an even worse crisis than the one we have just gone through. And there will be fewer options for policy makers, and none of them will be good or pleasant. And it will take most people unawares. They will see the current trend and project it into the future. And they will be hit hard.

Can we avoid this calamity? Yes, we can wrestle the US budget deficit back under some kind of control, close to nominal GDP or on a clear trajectory to get there within a reasonable time (say, a few years). As noted above, we can run deficits close to nominal GDP almost forever. But there is no political willpower to do that now. And so, the market will at some point force the hand of the political class. That investor in St. Louis, or China or (????) will decide not to buy government debt at such low rates. The avalanche will start. And everyone will be surprised at the ferocity of the crisis. Except you, gentle reader. You have been warned.

Let me re-emphasize that point. If we do not get our act together, the results could be truly serious. And it is not just the US. Japan, as I have written, unless it changes, will hit the wall in the next few years. There are some really sick actors in Europe. You are going to have to be far more nimble and prepared for this next crisis, should it arise, than you were for the last one. Over the next few months, I will be devoting some space to helping us think through how we do that.