Barbones' Blog

Would a Greek default be automatic doom?

Commentary: A review of past sovereign debt crises

 

CHAPEL HILL, N.C. (MarketWatch) — History may not repeat itself, Mark Twain famously once said, but it often rhymes.

 

And the rhyme that has caught many commentators’ attention in recent days is between what’s happening currently in Greece and Lehman Brothers’ bankruptcy in the fall of 2008. Just as that bankruptcy brought the world’s financial system to the brink of collapse, a Greek default could easily do the same today.

 

That certainly is very scary poetry indeed.

 

But it turns out that the Lehman Brothers-induced catastrophe is not the only thing with which a potential Greek default could rhyme. And some of those other rhymes turn out to have a much more pleasant sound.

 

In fact, prior to Greece’s recent difficulties, there have been at least four other occasions over the last two decades in which a potential sovereign default sent shockwaves throughout the markets. The stock market, on average, rose over the two years following those previous crises.

 

The sovereign debt crises to which I am referring are:

 

The Mexican peso devaluation and associated crisis, which began in December 1994

 

A government debt crisis in Thailand in the summer of 1997, which led to a run on that country’s currency and, in succession, many other Asian nations’ currencies as well — and which introduced into our lexicon the phrase “Asian contagion”

 

The Russian ruble devaluation in August 1998, which led to (among other things) the bankruptcy of Long-Term Capital Management

 

The Argentinian government debt/currency crisis that began in November/December 2001

 

The accompanying chart is based on a composite of how the stock market reacted following all four cases, with 100 representing the stock market’s level when those crises first broke onto the world financial scene. On average the stock market was 17% higher in one year’s time (or 252 business days on the chart). Furthermore, this healthy pace of advance continued well into the second year (as represented by the red line).

 

Notice in particular the blue line, which represents the stock market’s advance since Greece’s sovereign debt crisis became a headline worry in the U.S. (in late November of 2009). Notice that, within acceptable tolerances, the stock market this time around has followed a remarkably similar path.

 

Of course, since I don’t want to get an angry call from my college statistics professor, I need to stress that this “remarkable” similarity may simply be a coincidence. Any statistical analysis based on a sample of just four prior events has very little validity.

 

But, I nevertheless should point out, the bears are on no stronger statistical ground when arguing that a Greek default would have the same impact on the world financial markets as the Lehman Brothers bankruptcy.

 

The general lesson to draw from all this is that finding historical events that “rhyme” with what’s going on right now involves a lot of picking and choosing. The bears pick those precedents that bolster their pessimistic outlook, while the bulls gravitate to those analogs that reinforce an optimistic forecast.

 

Call it the battle of the rhymes.

 

By showing the bullish rhymes in the chart above, I don’t mean to suggest that the stock market will continue to go up in the event of a Greek default. My point is simply to remind us that the Greek default doesn’t have to rhyme with Lehman.