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ECB has tools to avert Greek default

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bank_2 October 4, 2011 (Chinavestor) It may seem absurd for China stock investors to spend a whole lot of energy analyzing Greece's debt problems for the first sight. Remember, Greece's DGP amount to $310 billion, nothing compared to $10,090 billion for China. Yet this small country has a real impact on equity markets around the world.

While we are fully aware of the possible fallout of a Greek debt default, This is why Greece is a big deal, there are plenty of room left for a favorable outcome. And when that happens oversold technology and transportation stocks, among others, will make a significant comeback.

Greece's debt problems are stemming from the 2004-2008 area when debt was cheap and the spread between German and Greek bond yields were at historical lows. But as the global economic crisis hit, liquid debt markets dried up and spread between the Bund and Greek government bonds soared. Fast forward to 2010-2011. Greece finds itself in a situation where the county has more debt than its annual GDP while yields are way too high for Greece to escape the debt trap.

But the European Central Bank (ECB) as well as heavy weight politicians, Germany's Merkel and France's Sarkozy, are well aware of a possible fallout of a Greek default. Read  Bronte Capital: Models for a Greek Sovereign Default for an interesting analysis of such scenario.

And here is the good news. The ECB has tools at its disposal to avert such scenario! The ECB has no limit on its balance sheet to fund a Greek rescue fund, buying up all Greek debt to keep the country afloat. Remember, the ECB is the depository of the euro, which is a public good. Should the recognised capital of the European Central Bank turn negative due to excessive lending to Greece, that would make no dent on its standing. The ECB can ask member states to recapitalize it or just simply credit itself and bring it forward as retained loss on its books. The case is similar to that of the FED that can print as much dollars as it wants to avert a U.S. default on its dollar denominated debt. For this technical reasons a U.S. default is technically impossible just as is Greece's as long as the ECB decides to keep funding it.

Greek Prime Minister Vanizelos shocked the markets over the weekend admitting the country will not meet goverment deficit targets. But today announced that the country has enough cash to go up until November. That gives plenty of room for ECB officials and politicians to stabilize the common currency. The risks are too high not to keep Greece afloat.

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