GREECE, VERSAILLES AND THE FUTURE OF THE E.M.U.
By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman
No last minute miracle has the Greeks headed to new elections next month. Syriza’s Tsipras appears to believe he has much to gain from a new round of elections. Polls put Syriza in first place, though the margin of error makes it look more like a dead heat with the New Democracy, led by Samaras. Samaras was a significant obstacle to reaching agreements earlier but now has been outflanked by Tsipras. Tsipras apparently did not drink a sufficient amount of the kool-aid that made Samaras more of a realist.
Many observers are confusing the Greek opposition to austerity regime with a desire to leave monetary union. Judging from the electoral results, a majority of Greeks are critical of the EU/IMF/ECB demands in exchange for assistance. However, polls show that 80% or more Greeks want to keep the euro.
There is room to compromise. Can any one doubt, for example, Keynes’ loyalty to the UK even though he passionately warned that the Treaty of Versailles was poorly thought out and would lead to no good? Are not the Greek people saying the same thing as Keynes was saying then?
First, as Keynes noted then, there is a limit on how much people would sacrifice current output to service foreign held debt. Up until earlier this year, aid to Greece seemed to be largely a stealth bank bail out. After the PSI, upwards of three-quarters of Greek debt is in the hands of the Troika (ECB/IMF,EU). They purposely acted to avoid participating in Greece’s debt relief even though, by most accounts, Greek debt was still not on a sustainable path.
Second, under the conditions of the modern era, Greece has been occupied by its creditors. It was forced to pass a law that prioritizes servicing debt (largely in foreign hands) over other claims on the public purse. Is this not the kernel of truth in Tsipras’ claim that the EU has imposed “barbarous demands” on Greece?
Third, France’s new president wants to renegotiate the fiscal compact that his predecessor helped draft and support. Why shouldn’t a new government in Greece seek to renegotiate the terms of its aid, which is not really so much aid for Greece as it is aid to keep its (now largely official) creditors whole?
Fourth, exacting onerous concessions from Greece threatens to destabilize Europe as much as the onerous demands at Versailles undermined European stability.
Given the extent of the international assistance, TARGET 2 exposures, and commercial bank activity, a total default by Greece could cost Europe (and IMF) an estimated 400 bln euros. With new firewalls (IMF/ESM) and the liquidity provisions (LTROs), Europe is in a better position to cope with this than say a year ago, which belies the derogatory epithet of “kicking the can down the road”, nevertheless, it cannot be confident that the extent of the contagion can be known a priori (see Lehman, six months after Bear Stearns).
There is no mechanism to eject a member of the euro zone any more than there is to evict a state of the United States. Still, life can be made unbearable for Greece within the euro zone. Without a printing press, the Greek government can run out of currency to pay social security and public sector wages. This is partly because Greece still runs a primary budget deficit (budget balance excluding debt servicing costs). That means that tax revenues continue to fall short of spending.
The ECB could also stop lending to Greek banks and refuse to sanction any more emergency lending (ELA) from the Greek central bank. These two steps would leave Greek officials little choice.
German Finance minister Schaeuble who is likely to replace Juncker as the head of the Eurogroup is touting a tough line. No room to compromise. Either Greece adheres to the agreements or it can leave monetary union. We have seen this tactic before. Schaeuble is the bad cop so Merkel can be the good cop.
Spain and Italy have openly acknowledged they will not achieve the budget targets agreed to with the EU. The new EU forecasts showed that other countries will unlikely meet their targets. That is not a cause for ejection, but a case for forbearance.
There is plenty of room for compromises and there is a great deal of posturing, which is part of the brinkmanship tactics. New EIB funds and structural funds are available (and already earmarked for Greece) can be deployed. There is some flexibility with the timing of budget goals.
It is preferable to the alternative of Greece leaving. The contagion impact of Grexit is unponderable. We argue that Greece is largely a symptom of the crisis not the cause. A Grexit could trigger a new banking crisis. It could heighten the pressure on Spain and Italian sovereigns, which in turn would squeeze domestic banks. It could lead to pressure on Portugal (if not others) to join Greece. It would be understood as a failure of European elite in general and Germany in particular.
We have argued that exiting EMU would not solve Greece’s problems. It would exchange them for a more dire set of problems, which would include a collapsed banking system, a deeper recession/depression, higher unemployment and higher inflation.
Leaving EMU and the EU could also impact geo-strategic interests of the US and Europe. An aggrieved Greece could turn to Russia for financial assistance, perhaps in exchange for basing rights, or Iran for its energy needs.
We recognize the risks of a Grexit to have increased primarily as a consequence of brinkmanship tactics from multiple parties. However, we continue to see a Greek exit as an expensive folly for all concerned.
7 Comments
I can’t read another Greek solution that is no solution. Fear. Fear of a financial crisis if u do what’s best for u, not for the banks. Not for those who lent money to those who could never pay it back.
They want you to fear something that u should not.
I side with Dr. Hussman. They always site how bad it will be if u do what should have been done. They always advocate more of the same. If we allow greece to leave the world will end and u don’t want Greece to experience a deep depression??? Ugh u mean like right now. I wish Icelanders could speek Greek.
Look…. Just because the outcome the solution is tough doesn’t mean u avoid it.
You go right at it. Get it done. Do exactly what the experts and politicians who got u I to this mess are telling u not to do. Exit the EU.
Sooner than later… I need a holiday… And in spite of what the experts say I’m going where my
Money goes along way. I give Greece 18 months and the place will be humming. They’ll cry when they realize how bad the advice was they followed. They keep running the same play .. Thinking maybe it will work.
For once since LTCM blew up can we stop using Lehman as a reason to not do what’s needed. It was t Lehman but the way they handled it. If what the writer said is true. That the Euro does not have a way to allow a country out of it . Then as my father always said when I was in a pickle. ” son u have one foot on the dock and one on the boat u better figure out which direction your headed or your going to lose your nards” yes.. (He actually used nards.)
Well Europe if u don’t have an exit plan.. Don’t u think u better get on that.
Willy2 s bond vigilante gang is about to go Mexican Cartel mothers day on your yields!
http://globaleconomicanalysis.blogspot.com/2012/05/note-to-ambrose-evans-pritchard-at.html
I have closed 2/3 of my silver and gold short positions as of today after a couple of months of serious decline (big profit). I also went 25% stocks long with my equity in a basked of oil/gas corporations (hedged partially through options) and a small position in Spanish ETF. I’ve quit all my oil short positions.
A bounce looks like appropriate at this levels, before continued decline and deterioration happens. Personally I think we have seen the highs for the year and further drops or non-panic selling will continue as situation deteriorates (with possible cascade drops later this year), but now I want to be long and will stay until I see signal of going back to being net short again. If this rebounce does not have much legs (SPX 1370-80 at least) is a dangerous sign of a sell off IMO.
P.S: The EUR/USD big move to the downside call was correct after all I made a couple weeks back looking at price action and how low volatility had become.
@Leverage, thanks for sharing your investing/trading strategy. It looks like a weak bounce so far today. I’m holding mostly bonds and bond etf’s here, waiting for a blowoff top in safe haven bonds at some point, then I hope to sell at the right time. Also holding a few defensive equity etf’s but only 13% long equities here, as I fear that we may not see much of a bounce here.
The quality bonds trade has been a good one and if you had a good entry I wouldn’t be in a hurry to dump em even if you can’t expect much upside (specially in long term public debt), I see the risk of yield going up and the prices going down close to zero and this one is almost crystal clear to me. Bond bears have been wrong for so long that you may have guaranteed success just by doing the contrary they say. I personally sold my position because I though I had better stuff to put money on, but now I’m not so convinced and still that blow off top you speak about could happen.
Anyway… yeah it’s not like I’m extremely bullish, I still have 1/3 of my original shorts on PM’s (lucky me because silver dropped a lot today). Also have to close a large position of short XLF calls expiring this Friday, and I may repeat this trade.
One thing I miss is having positioned myself in the natural gas futures market though even when I’ve been looking at it since some months ago. But at least I’ve indirect exposure on that through equities (which have closed plain to slightly red today despite index declines, and the technicals and fundamentals look very good to me). And my position on Spanish index is a long term martingale strategy, so is a small position right now, I easily think the index could decline 20% more from here to 2013.
In any case, SPX cash sitting at 1324 right now, I sold months ago at 1320 and moved onto other things and haven’t regretted missing these last 80 or so points because I’ve more than made up in other markets. As I said back then to VII, why should I care about the SPX when I’ve things to invest in that I see more clearly… It’s why I’m buying right now some stocks even if the direction of the market as a whole has changed, I can risk a big decline in these stocks just to be positioned to the upside because it looks like a convincing theme to me and the market is pointing in that direction, also could use a small part of my profits to hedge decently against short term pain (hell the further decline in PM’s today more than covers my hedging costs).
I will continue to look for opportunities in both the selling and the buying side.
Good Stuff Leverage.
If we were at a night club in L.A my pick up line to you would be…”I couldn’t help but notice how beautiufl your Spanish ETF looks”.
I secretly want to to 50% into Spain and 50% into EuroStox and tell my clients to sit down shut up and enjoy the ride and then give them my personal bank account so they can showere me with the money I’ll make them.
I don’t see any support for the S&P before 1270 (the 200 day). If it then would rebound to only 1370, that would be a very bearish sign. Spain broke support of 2009 lows, should be moving lower in the short term too.