Why you’ll pay for the Greek exit

Well I’m sure you’ve had your fill of the 'Grexit' story. It was all over the news and papers at the weekend... everyone’s talking about it.

Of course the very real possibility of a Greek exit from the eurozone is hardly news to us here.

So let’s move on to the bigger question. And that is: Who pays if Greece exits?

You pay!

The Greeks are, how shall I put it, very upset.

They’re upset with the main political parties, who many feel have sold them out to the wicked Europeans. Youth unemployment is over 50%, while in Germany, it’s fallen. Greek banks are haemorrhaging cash, while it piles up in Germany. Greek bond yields are heading out of the ball-park, while the German government can borrow for practically nothing.

The words the public want to hear are uttered by an effervescent young-gun politician called Alexis Tsipras. And his calming words are something like: Let’s just dump our debt obligations.

And the obvious question we should be asking ourselves is...

Who loses?



If Greece exits the euro, then the question is, how much will lenders get back? Of course nobody knows, nor do they know which currency they may get back. But we do have an idea of who’s holding the debt.

As the graphic shows, Greek debt holders can be split into three distinct groups, all of them with about a third each. There’s the ECB/IMF, who have bought in to try to stabilise the Greek debt market. There’s the Greek and Cypriot banks, that bought in for regulatory reasons (a risk-free asset for bank reserves) and pension savings. And last, but not least, there’s everyone else, or the ‘market’ – and  that could include your pension fund.

But don’t worry too much, as it’s much more likely to be French pension funds or banks left holding the baby. The following graphic explains why...
Who does Greece owe?

Source: BBC

I can see 41 billion reasons why the French are keen to keep Greece within the eurozone!

But an exit will hurt the Greeks most

Though I have argued strongly that it’s in Greece’s interests to leave the eurozone, I’m not for one moment suggesting it’s going to be easy.

The rest of the world can probably cope with Grexit. It’s only if other countries follow her out the door that we’re in big trouble. But for Greek banks and pension funds, it’ll be shocking. They’re filled to the rafters with their own Greek debt.

Older (and wealthier) factions of Greek society will pay a very heavy price in the event of Grexit.

It’s little wonder that euros are heading out of Greek bank accounts. If you face losing a large chunk of your pension, then you’re not going to run the risk of your cash going up in smoke too.

Greek businesses will be next to suffer

I remember when Argentina faced a similar exit. I remember it well, because I was in the throes of an important business deal with an Argentinean. And it nearly bust my business...

Argentina faced an exit from its dollar peg. Argentina was in a similar situation to Greece today. Basically, her currency was ‘pegged’ to the US dollar, and had been for ten years. But given the distortions caused by an ill-fitting monetary union, it couldn’t hold on. Deficit spending and debt had become too onerous. So the Argentineans needed loans from the IMF to keep up the charade of monetary union.

Everyone could see what was happening. Bank accounts were being emptied as holders feared a currency devaluation.

I’d just started a food import business. And one of the first deals I did was the sale of two containers of organic honey to a large UK buyer.

I had signed a contract that promised to deliver. But suddenly our Argentinean supplier didn’t want to go through with the deal. He didn’t want our dollars – he was frightened that once received, the cash would be debased. He said he’d rather sit on his honey. For him it was literally liquid gold.

And he was right... upon exit, the value of the peso fell to about a quarter.

Thankfully I was able to wriggle out of the deal with the UK buyer. But they weren’t happy, and they could have made me go out and buy the honey elsewhere and deliver it to them at a massive loss.

The point is, when you start publicly debating the exit from monetary union, international business grinds to a halt. Nobody does anything for fear of converting their hard work into debased currency.

I say if Greece heads out the door, it should be done as quickly as possible. Greece can’t afford a drawn out withdrawal. Every day spent in limbo causes more and more economic heartache.

The pain is going to be shocking. But not as shocking as hanging on.

Somebody ought to tell the politicians.


Bengt Saelensminde

Cash is King, deflation begins

“Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate...  it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."

- Andrew Mellon       

Down, down, down...

Oil is at a five-month low. Russian stocks are 20% below their high. Commodities are back to 2010 levels.

Everything is going down. Even gold.

Wait a minute. Since we know from Einstein that all motion is relative, everything CAN’T be going down. If everything were going down, everything would be standing still. Something must be going up as a point of reference.

So what’s going up?

Cash!

Cash is going up against oil, houses, stocks, copper, commodities of all sorts...  and just about everything else.

Cash is king.

Why? Because we are in a Great Correction. And in a great correction, prices are corrected. In a bubble, prices tend to go up. This tends to push up animal spirits... encouraging investors and business people to do things that they will later regret. They build houses no one can afford... and shopping centres no one really needs. Then, these things – and the loans against them – appear as “assets” on the books of banks, pension funds, hedge funds, private equity outfits... you name it.

Later, as the correction continues, markets discover that these ‘assets’ are not worth quite as much as they thought. Prices go down. Some ‘assets’ become liabilities. They are underwater, with more debt than equity.

Labour rates fall too. There are fewer projects that “make sense”... and they need fewer workers. Business falls off. Unemployment goes up. Salaries go down.

As prices fall, they must fall against something. So they fall against cash. Cash becomes more valuable. You can buy more real assets with every unit. People who hold their cash through a correction usually do well. They are able to buy quality assets, at the bottom, at large discounts to their previous prices.

That’s why so many people are willing to lend money to the feds for such low interest rates. They figures it’s as good as cash.

All this is obvious and hardly worth mentioning. In a better world, we’d all know what was going on... and we could all predict what would happen next: the mistakes would be written off, defaulted on, foreclosed, and marked down...

... and then, the economy could get up, dust itself off, and get back to work.That’s what used to happen. The first American depression came in 1819. Cotton prices collapsed. Farms were foreclosed. Banks failed. It was over by 1821 – two years later.

Then, there was the Panic of 1837. New York brokerage houses failed. Farm prices collapsed. A bank president committed suicide. But it was over by 1843 – six years later.

The Panic of 1857 was triggered by the bankruptcy of Ohio Life Insurance and Trust Company. Railroad speculators were ruined. Stocks plunged. Nearly a thousand companies went broke. The resulting depression was hard... but short. Recovery began two years later.

The Panic of 1873 led to a five-year depression. And the Panic of 1893 hit even harder – with a crash on Wall Street, 16,000 business failures and a 15% unemployment rate. Four years later, the economy was running hot again.

The aftermath of WWI brought the Depression of 1921. By many measures it was as bad as the Great Depression. But it was quick – two years later it was over.

And then, came the Great Depression itself. What made it so great? The feds! Until the 1930s, the feds let the economy take care of itself. Interest rates? They were set by willing buyers and sellers, not by economists working for the government. Monetary policy? Fiscal policy? There were none.

When it was time for a correction, Mr Market took out a wrecking ball and knocked down the mistakes of the previous boom. The debris was quickly swept away... and it was off to the races again.

Even as late as the 1930s, Andrew Mellon, then Secretary of the US Treasury, advised president Hoover to “liquidate” everything. His idea was to give the correction a helping hand...  Rather than wait for the correction to do its work, he’d swing the wrecking ball himself.

That is just what he did in the 1920s. He was Treasury Secretary in 1921 too. And instead of trying to fight the slump of ’21-’23, he helped it on its way. Instead of “countercyclical stimulus” measures, he gave the nation “pro-cyclical” measures. That is, he didn’t increase government spending in order to provide the economy with fiscal stimulus. He cut government spending in order to leave more money in the hands of consumers, investors, and business people.

And it worked. Scarcely 24 months after the beginning of the depression it was over... with unemployment back to 5%.

But the world changed between ’21 and ’31. By the ‘30s, the feds had the bit between their teeth. In Germany, the Nazis were already consolidating power and gathering tinder for the Reichstag. In Italy, Mussolini and his gang were wearing funny outfits and plotting out an empire. Stalin was reorganizing Soviet agriculture – which would result in millions of deaths by starvation. And in the Western democracies, the meddlers were taking over too.

Instead of thanking Mellon for his input, the feds tried to impeach him! In a few months, Mellon was gone. And then US economic policy was firmly in the hands of people who thought they could do better.

The gist of the new policy was that corrections must be stopped – at all cost. Depressions must be fought. Bankruptcies must be prevented...  Markets must be controlled! By bureaucrats!

This new policy was what made the Great Depression great. Mr. Market may have wanted to correct his mistakes; but the feds wouldn’t let him. The depression continued, off and on, throughout the ‘30s... and the ‘40s too. It didn’t really end until the 1950s.

You might expect the feds would have learned from that experience. Compared to the laissez faire policies of Andrew Mellon their activism was a complete, miserable failure.

Learn? Are you kidding. We’re now in the 6th year of the crisis that began with the collapse of subprime in April ’07. Does it show any sign of letting up? Any sign of coming to an end?

Nope?

The feds have fought the correction every step of the way... with everything they’ve got. They’ve tried monetary stimulus – taking rates down to zero.

They’ve tried fiscal stimulus – with $1 trillion budget deficits for the last four years... and no end in sight. They’ve tried 'unconventional' measures too – such as QE 1, QE II and The Twist. Last year, the Fed funded more than 60% of the US deficit with printed money. And the Fed has increased its holdings of US debt some 3.5 times since 2008, from $479 billion in September, 2008 to $1.66 trillion in March, 2012.

So, put on your seat belts. Sit back. Relax.

Eventually, the correction will do its work. But it could take a long, long time.

Bill Bonner

What the European elections mean for you

As we’ve noted before, politics holds the key to the euro’s future.

The euro is a political construct, not an economic one. As it stands, the euro cannot function in the long term, from an economic point of view. The various countries involved are too different.

So the main thing holding the euro together so far is that European voters, by and large, still want it. Voters might be angry at Germany, or angry at their own leaders, or angry at eurocrats in general.

But they don’t yet blame the currency for their woes, this could be the year that all that changes

Forget growth versus austerity – it all comes down to defaulting

Sharing a currency and nothing else is a recipe for disaster for smaller countries. Scotland plans to keep the pound if it pursues independence. But it perfectly sums up the problems that the eurozone faces.

Forget all the stuff about austerity versus growth. It’s good column fodder for economists, but it doesn’t get us any closer to understanding what will happen on the ground.

The austerity mob argues that countries need to do what it takes to pay back their debts. Instinctively, this feels like the ‘right’ decision. Most of the time, if you’ve spent too much money, then yes, cutting back for a while and rebuilding your savings is the smart thing to do.

But there comes a point where the hole you’ve dug is simply too big. That’s when your creditors need to share the pain. People seem to forget that when a lender writes a cheque, they’re taking a risk. If they haven’t assessed that person’s credit risk correctly, then the rules of capitalism dictate that they should lose some or all of that money.

So austerity without explicit default cannot work.

The growth mob, on the other hand, seem to think that you can borrow and spend with impunity. This is wrong, and they know it. What the growth guys are really arguing is that Germany should take the leash off the European Central Bank (ECB).

If the ECB is allowed to print money, then Greece and all the other countries can service their debts the easy way – the Anglo-Saxon way, in fact. Over time, these economies will recover.

It does mean that you confiscate money from savers across the eurozone in the form of inflation. It also means that you are implicitly defaulting – you are repaying your debts with devalued currency.

And it creates moral hazard – neither countries nor lenders have any incentive to change their behaviour if they believe that there is always a bail-out at the end of the road.

So these are the choices: an implicit default or an explicit default. In an implicit default, German taxpayers agree to stand behind other nations’ debts (in the form of ECB money-printing, or a common eurozone bond issue – it all boils down to the same thing). That leads to a weaker euro.

In an explicit default, Greece tells its remaining creditors (the ones it hasn’t already defaulted on) that it can’t repay them.

Trouble is, any eurozone country that unilaterally decides not to pay its debts would be stiffing other eurozone countries too. In particular, a whole lot of Greek debt is held by other European banks, as well as the ECB. That’s why it would be hard to default, and also to stay in the euro.

So an explicit default by Greece (or any other country for that matter), involves leaving the euro and going back to the drachma.

So what’s the European endgame?

Which of these routes will be chosen all comes down to the voters. So what have they said?

The key country is Germany, of course. And they have no intention of budging. As Reuters reports, Volker Kauder, one of Angela Merkel’s “closest allies”, said: “Germany could end up paying for the Socialist victory in France with more guarantees, more money. And that is not acceptable. Germany is not here to finance French election promises”.

Merkel is only reflecting the desires of her population. So while Francois Hollande can talk about growth all he wants, the best he’s likely to get is some sort of fudged ‘growth pact’ that is all words and no action. That won’t please the French people. But they’re not at the stage where they are ready to jack in the whole euro project as yet.

The Greeks, on the other hand…

In essence, the outcome of the Greek election was a mass vote for “anything but this”. Greeks voted for Communists, Neo-Nazis, and all the colours of the political rainbow in between. Putting a coalition together from that lot is going to be tough. In fact, it seems likely that there’ll be another election in June. Although, chances are, that would result in an even more polarised result.

Citigroup reckons that there’s now a 75% chance of Greece leaving the euro by the end of 2013. That seems more than reasonable. The question is, how much damage could it do?

Private debt holders have already had their holdings written down substantially. So it’s hard to believe that losing the rest would deliver a knock-out blow to the global financial system.

However, it would still be incredibly messy, but it would also get the markets watching for the next candidate to leave – probably Portugal.

The one thing that a Greek exit might do, is shock the rest of the eurozone into deciding that defaulting via money-printing is the best way to go.

In the meantime, I’d keep your exposure to the eurozone to a minimum. But have some cash in your portfolio, ready to take advantage of any opportunities that arise. If the ECB does have its arm twisted into money-printing, a rally is almost guaranteed.

John Stepek