How Big Will The Greek Default Be?

This fine chart is courtesy of the Daily Reckoning.

It is clear to me that there no longer is a question of if Greece will default, but a matter of when. Greece was overextended in 2007 when its debt to GDP reached 100%. Now as the 160% level approaches, the bond market reacted by pushing yields to over 16%!

For a nation to continue making payments on debt, it must collect enough revenue in taxes and tariffs to cover not only the interest payments on debt, but the principal payments and costs of government services.

If we consider that government spending and debt service has a ceiling in the 20 to 25% of GDP level, let's look at recent history to see how large a haircut the bond holders will take.

In 2007, at around 4% interest, the total cost of interest is 4% of GDP since debt is 100% of GDP. This leaves 16 to 21% of GDP from tax collections for principal retirement and to fund government services.

By 2010, yields skyrocketed past 10% on 10 year bonds, and the total cost of interest climbed to 14% of GDP since total debt has also increased to over 140% of GDP.
This leaves only 6 to 11% of GDP from tax collections toward principal and government services while GDP is shrinking!

Under a default scenario, yields would remain very high, say 15%, while tax collections would be weak.

It is conceivable that the interest portion of 4% of GDP is sustainable, so debt would need to drop to 27% of GDP in a 15% yield world for the Greeks.

This represents a 73% haircut for bond holders!

No wonder current Greek short term bond yields are close to 24%.

Personally, I'll will stick with gold and stay away from Greek bonds no matter what schemes the European Union comes up with in an attempt to kick the can down the road by "restructuring" the debt.