Greece’s End Game; Unravelling The #Grexit

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Tom Janssen / The Netherlands, PoliticalCartoons.com

On Friday, the Greek Prime Minister Alexis Tsipras, after months of fruitless negotiations, asked for a referendum on whether Greece should accept further austerity in exchange for continued bailout support from the IMF, or whether it should reject creditor demands, a decision which would mean defaulting on its sovereign debt obligations and effectively leaving the Euro.

If this is meant to terrify Greece’s creditors, they seem ready to call the bluff. The deadline for Greece’s current payment to the IMF (1.5 billion) is June 30th, the proposed referendum is to be on July 5th. This means that Greece will default before it’s had a chance to decide on whether they should default. If this seems like a grim picture for Greece, you have no idea how bad it is about to get.

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Since 2008 Greece has limped along, periodically looking as though it is going to default on its massive and unmanageable debt. In 2010, when it seemed like a default was inevitable a bailout was organized that mandated strict and painful austerity in exchange for the financial aid needed to keep Greece within the EU. That austerity has left the Greek economy in shambles. Unemployment sits at around 25%, while pensions have withered, as have government jobs and a shrinking healthcare budget. Greece lost nearly 25% of its GDP from the pre-crash high, a rate unmatched by any other heavily indebted Euro country facing similar austerity measures.

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Hindsight being what it is, that bailout was probably a mistake. At the time however, following the collapse of the American banking system, sidestepping a default likely seemed the best idea for every party. But several years on the Greek people were desperate for anyone that could change the fate of Greece within the Eurozone. The seeming saviors for Greece came from the leftist coalition Syriza, which promised to end the tyranny of austerity while retaining Greece’s place within the Euro.

Greece’s history with finances is checkered, if we are being generous. Greece has defaulted on its sovereign debt obligations five times since independence, and has been in default for nearly 50% of its time since gaining independence. Greece’s financial problems are also largely of their own making, having borrowed extravagantly at low interest rates and greatly expanded its government services while ignoring taxes has not earned it many sympathetic allies within the Eurozone.

This guy is Alexis Tsipras and he is the PM of Greece. He is not going to be remembered the way I think he wanted to be remembered.
This guy is Alexis Tsipras and he is the PM of Greece. He is not going to be remembered the way I think he wanted to be remembered.

But Greece’s situation is now quite dire. Greece produces little, has only a modest economy and owes far more money than it can ever reasonably expect to pay. Its economic prospects are slim and to retain any economic stability means adhering to austerity measures that gut and change pension obligations, raise taxes, reduce government sizes and heavily restrict benefits. That may be necessary tough love but it is also deepens Greece’s depression and throws into chaos the future of many Greeks, who only a few years ago thought they knew when they could retire and with how much money.

Syriza’s attempt to win concessions from Greek creditors and ease the austerity it was facing have largely backfired. Incorrectly assuming that a default would produce more pain for Europe than Germany and the ECB would willingly endure was a miscalculation that has left Greece in an even worse situation. With no cards to play the only options now facing Greece are more austerity within Europe, or even greater austerity outside of it.

Choosing austerity within the euro would at least mean keeping some of the economics on track, and would allow the government to access in excess of 15 billion in continued bailout funding. But the path now set by Tsipras, seeking a referendum five days after the deadline seems to have set in motion an even worse set of events.

From The Economist. Greece remains an outlier within Europe, even amongst other heavily indebted nations.
From The Economist. Greece remains an outlier within Europe, even amongst other heavily indebted nations.

The continued uncertainty in the negotiations through June has been putting considerable strain on an already taxed banking system. As negotiations have dragged on, Greek citizenry have been making significant withdrawals and transfers at their banks. To avoid a run the banking system it has been propped up by the ECB with Emergency Liquidity Assistance. But after yesterday’s referendum announcement the pressure on banks reached a breaking point. Thousands lined up at ATMs to get their hands on as many Euros as possible. In response the government has suspended banking for the next week and promised new capital controls to restrict transfers and withdrawals. That’s only the beginning of Greece’s banking woes.

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Rick McKee / Augusta Chronicle

The ECB has said that if Greece defaults the emergency liquidity assistance will end, which means also a collapse of the Greek banking system. And while there is no official requirement for this ECB position, the unofficial reasons are obvious. Default cannot seem like a viable path for the austerity stricken countries, and financial markets need to be reassured that EU members won’t willingly walk away from their financial obligations to satisfy voters.

This means that a Greek exit will be worse than accepting continued austerity. It will mean more unemployment, poverty, government cutbacks and shrinking services. There is still time for a deal. The government can accept the creditor demands, institute further austerity, avoid a banking collapse and continue to use the Euro. But that may only postpone a fate we all know is coming. Greece’s debt is still too large, its economy too small, its creditors too stubborn and its options too limited to change the course it is on. Greece was always destined to fail, and sometimes we must come to learn that not all problems have solutions, only outcomes.

 

Why It Matters If The Fed Raises Rates

628x471This summer might prove to be quite rocky for the American and global economies. The smart money is on the Federal Reserve raising its borrowing rate from a paltry 0.25% to something…marginally less paltry. But in a world where borrowing rates are already incredibly low even a modest increase has some investors shaking in their boots.

Why is this? And why do interest rates matter so much? And why should a small increase in the government borrowing rate matter so greatly? The answer has everything to do with that financial black hole 2008.

I asked NASA to use the Hubble telescope to take a photo of the 2008 financial crash. This is what it looks like from space.
I asked NASA to use the Hubble telescope to take a photo of the 2008 financial crash. This is what it looks like from space.

No matter how much time passes we still seem to orbit that particular mess. In this instance it is America’s relative success in returning economic strength that is the source of the woes. Following the crash their was a great deal of “slack” in the economy. Essentially factories that didn’t run, houses that sat empty and office space that was unused. The problem in a recession is convincing 1. Banks to lend to people to start or expand businesses, and 2. to convince people to borrow. During the great depression the double hit of banks raising lending rates and people being unable to borrow created a protracted problem, and it was the mission of the Federal Reserve in 2008 to not let that happen again.
US GDP Growth 2012-2015 source: tradingeconomics.com

To do that the American government stepped in, first with bailouts to pick up the bad debt (cleaning the slate so to speak) and then with a two pronged attack, by lowering the overnight lending rate (the rate that banks can borrow at) and then promising to buy bonds indefinitely, (called Quantitative Easing). The effect is to print mountains of money, but in ways that should hopefully stimulate banks and corporations to lend and spend on new projects. But such a program can’t go on for ever. Backing this enormous expansions of the treasury requires borrowing from other people (primarily China) and the very reasonable fear is that if this goes on too long either a new financial bubble will be created, or the dollar will become worthless (or both!).

Today the Fed is trying to determine whether that time has come. And yet that answer seems far from clear. Investors are wary that the economy can survive without the crutch of cheap credit. Analysts and economists are nervous that raising rates will push the US dollar higher, making it less competitive globally. Meanwhile other countries are dropping interest rates. Germany issued a negative bond. Canada’s own key lending rates was cut earlier this year. People are rightly worried that a move to tighten lending is going in the exact opposite direction of global trends of deflation. If anything, some argue the US needs more credit.

The question of raising rates reveals just how little we really know about the financial seas that we are sailing. I often like to point to Japan, whose own economic problems are both vast and mysterious. Lots of research has gone into trying to both account for Japan’s economic malaise; it’s high debt, non-existent inflation, and how to resolve it. Currently the Japanese government is making a serious and prolonged attempt to change the country’s twenty year funk, but it is meeting both high resistance and has no guarantee of success.

Similarly we have some guesses about what might happen if the Fed raises its rates in the summer or fall. Most of the predictions are temporary instability, but generally the trend is good, raising rates usually correlates to a stronger and more profitable market.

But that’s the key word. Usually. Usually European countries aren’t issuing negative interest rates on their debt. Usually we aren’t in quite a pronounced deflationary cycle. Usually we aren’t buying billions of dollars of bonds every month. Usually.

The answer isn’t to ignore the bad predictions, or obsess over them. The best idea is to review your portfolio and make sure it’s anti-fragile. That means incorporating traditional investment techniques and keeping a steadfast watch over the markets through what are often considered the quiet months of the year.

What Investors Should Know After Europe’s Terrible, Horrible, No-Good Month

cartoon spin bull vs bearFalling inflation, terrible economic news and a general sense of dread for the future seems to have once again become the primary descriptive terms for Europe. Earlier this year things seemed to have improved dramatically for the continent. On the back of the German economic engine much of the concern about the EU had been receding. 2013 had been a good year for investors and confidence was returning to the markets. Lending rates were dropping for the “periphery nations” like Portugal, Greece and Ireland, giving them a fighting chance at borrowing at affordable rates. But first came the Ukrainian/Russia problem which caused a great deal of geo-political instability in the markets. Then came October.

I don’t know if Mario Draghi cries himself to sleep some nights, but I wouldn’t blame him. Despite the best efforts of the ECB, Europe looks closer to being in a liquidity trap then ever. Borrowing rates are not just low, they’re negative, with the ECB charging banks to now to deposit money with them. October also ushered in a string of bad news. For Germany, easily the biggest part of the Eurozone’s hopes for an economic recovery, sanctions against Russia have hurt the manufacturing sector. Germany began the month announcing a steep and unexpected decline in manufacturing of 5.7% in August, the biggest since 2009. This news was followed by criticisms of Germany’s government for not doing more infrastructure investment and being too obsessed with their strict budget discipline. Yesterday 25 banks in the Eurozone failed a stress test, a test that was meant to allay fears about the health of the financial sector.

For Europe then things look bad and even if the situation corrects itself over the next few months (sudden shifts in the economy may not always be permanent and can bounce back quickly) the concerns over Europe’s future will likely undermine any efforts by the ECB to properly stimulate the broad economy and encourage investment on a mass scale. By comparison it looks like the United States is having a party.

The US economy seems to be on track to grow, and as the world’s biggest economy (though there is some dispute) the country is fighting fit and especially lean. Cheap oil from shale drilling is helping the manufacturing sector, making the United States more competitive than South Korea, the UK, Germany and Canada, and the sudden drop in the price of oil is a boon to the US consumer to the tune of nearly 50 billion dollars. Consumer confidence is up, as is spending. Debt levels are down, both for companies and households. Most importantly the economy seems to be tipping over into an expansionary phase, with corporations finally starting to put some of their money to work.

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The coming months could be interesting for investors as we return to a time where once again focus is on the US as the world’s primary economy.Screen Shot 2014-10-28 at 12.32.45 PM The concerns of 2008, that the American consumer was done, the country had seen its best days and its corporations would never recover seem far fetched now. Worries over hyper-inflation are as distant as a the never arriving (but inevitable) rate hike from the Federal reserve. Worries about Great Depression levels of unemployment are problems of other nations, not the US with its now enviable 5.9%, now encroaching on full employment. Old villains seem vanquished and even Emerging Markets, long thought to be entering their own golden era, are now taking a back seat to the growing opportunities coming out of the US.

Investors should sit up and take note. It’s possible that the best is still yet to come for the US markets, and if market conditions continue to improve this bull market could prove to be a long one.

Taking a Second Look at Europe

One of the benefits of being a financial advisor is the occasional one-on-one meeting you get with Portfolio Mangers (PM) and the opportunities to pick their brains. This week began for me by sitting down with AGF manager Richard McGrath, a PM based in Dublin who helps manage some global and european funds.

This was great opportunity to get some first hand information about what is going on in Europe. Following 2008, the Eurozone, easily the largest economy in the world, has been hit pretty hard. Strict austerity measures and public unrest have long painted a picture of a Europe constantly on the brink of failure. 2011 was easily the worst year as Greece got perilously close to defaulting on its debt as Germany and the Troika (the European Commission, the EU Central Bank and the International Monetary Fund) played hardball looking for more political concessions from Greece.

The fact remains that big financial crises like 2008 have long tails, and Europe has been beaten-up very badly, with big reductions in their GDP, large unemployment figures and generally all-round bad economic news. And yet no storm lasts forever. Despite a difficult political structure, a burgeoning recovery seems to be underway.

Richard McGrath seems to think so at least, and I share many of his views. Some of the good news is really less bad news. For instance in Ireland continued austerity was expected to cut €3.6 billion from government spending, but as the economy improves that number has been dropped to €2.5 billion. There are lots of little stories like this helping to outline a general recovery in the Eurozone. Bloomberg reported on October 23rd that Spain had ended 9 consecutive quarters of negative economic growth, with an anemic 0.1% growth rate. Not great, but it still goes in the “good news column”.

It’s worth remembering that negative news abounds in the United States, but their stock markets have reached all time highs (again) and that after several bad years European markets have also done very well this year. But from the perspective of watching markets its important to take notice when GDP growth turns positive (Germany, France, Spain, UK – Societe Generale, September 9, 2013), investment flows start gaining (Societe Generale), all the while valuations are considerably lower, and therefore cheaper than other well performing markets (Thomson Reurters Datastream, October 21st, 2013). All of this points to one conclusion, you can’t trust the media. With it’s constant focus on negative news you might miss some of the best growth opportunities!