When The Cure is Worse Than the Disease

GettyImages-480050662_0Last week most of the world was expecting a chaotic, but unavoidable Greek exit from the Euro, but following more final, final negotiations a deal was ultimately hammered out between Greece and it’s creditors. A quick glance over much of the media shows that many view the new bailout as a temporary reprieve at best, and an extension of a cruel policy at worst. Greece gets more debt, more austerity and zero concessions from Europe.

Greece has proven to be a needless problem for much of Europe, but one that has highlighted many of Europe’s fundamental weaknesses. Greece may have navigated itself into this mess, but it isn’t unreasonable to expect that solutions to Greece’s problems eventually look like, well, solutions. In short Greece needs one of three things. Either to be treated like a fundamentally poor state requiring transfer payments from the rest of Europe (unacceptable to Germany), relief in the form of debt forgiveness (unacceptable to the ECB, Germany and the IMF), or to exit the euro and revert to the drachma (unacceptable to Greece).

Notably none of these options has been pursued. Instead the status quo has been maintained to nobody’s satisfaction. The Greek government is outraged that the deal is effectively worse than the one they rejected. Most of Europe is upset at how poorly the negotiations were handled by both sides, and the brash and ultimately useless Alex Tsipras has ultimately failed in getting any of the concessions he thought he might secure through his brinkmanship.

There is some light at the end of the tunnel however. There is now some hope for debt forgiveness in the future. And if Greece hits its austerity and reform targets there may be continued relief on both interest rates for existing debt and the opportunity to push the payment dates farther out into the future. While this may signal some progress, the problems that underlie the Greek crisis still exist across Europe.

Those problems have everything to do with Europe’s loose federation and shared currency. I recommend the  above video to quickly explain the inherent problems within the euro. But for now it looks as though the only winner in all this is the integrated EU zone. Once again it seems that the decisions made were about protecting the European experiment, even as that experiment makes matters worse for Europeans. That raises questions again about what the point of the EU is if not to improve people’s lives.

The Three Most Dangerous Things This Morning

This week three big issues are defining the financial landscape

Greece Isn’t Done Yet!

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Despite a no vote in Greece over the weekend, the EU still believes it is within the collected interest within the Eurozone to stop Greece from imploding. Strong resistence seems to be coming from Greece on this issue as the Greek Prime Minister, Alexis Tsipras, swanned into Brussels with Cheshire cat grin and nothing in hand to negotiate with. Greece has five days to work out a plan with its creditors before being declared in default. While the Greek situation seems to be playing out at a glacial pace, the fact is that these tactics can only go on for so long, and eventually (presumably by the end of the week) a point of no return will be passed and negotiations will be moot. The stakes are high as a Greek default, while not insurmountable by European leaders, risks creating problems in other member states. That contagion is at the heart of German reluctance to cut Greece any slack and it is the real concern that is adding volatility to the market. Markets would like to see a sensible conclusion to the Greek problem since it will reassure everyone that the larger plan for Europe is still in place. A chaotic Greek exit from the euro could simply make matters worse.

China: Start Panicking and Throw Things!

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Ghost CitiesFor years people have scratched their heads at the curious case of China. China’s economy is huge and somewhat a mystery. Like most big economies, the government makes predictions about the future of economic growth. Unlike most big economies those predictions are always right and never need any revision. In addition to China’s always correct economic growth numbers, China has embarked on massive infrastructure projects. So massive that they’ve built entire cities where no one lives. This combination of big spending and highly suspect numbers has made many people wonder whether there is a looming problem within China that has yet to rear its head.

That problem may have arrived this month. The Chinese stock market has lost close to 40% over the last month and the government has had to step in to try and stop the collapse. So far that hasn’t worked. Prices in China have surged over the last few years as many smaller investors have not just placed money in the market, but borrowed to do it as well. While there were rules to stop “leveraged market mania” within the Chinese market, like all rules they were both weakened over time and people have found ways around them (you can read more about that in this May report: Credit Suisse Report on Chinese Leverage).

China has a market bubble and it’s in the process of deflating. Just this spring 20 million people opened stock accounts, while whole towns have given up farming so that they can play the markets. The Chinese government isn’t oblivious to this problem, and has taken extreme action to try an prop up the market, but whether that will work has yet to be seen. Meanwhile concerns that the market is collapsing is driving many investors to sell, exacerbating the situation.

Canada in Recession? What’s a Recession?

bocCanada’s economic situation is…unclear. At least, that’s the best case scenario. The regular reports from the Bank of Canada, The Financial Systems Review, which details risks within the Canadian market and has regularly highlighted that the indebtedness of Canadians poses the single greatest risk to the economy. If the economy were to change in any way that made servicing those debts impossible the effect would be serious. Since the December report, the Bank of Canada had made an unexpected rate cut to help prop up the economy which was being affected by the falling price of oil. The June FSR (which you can read HERE) stated the same thing, but hoped that an improving American economy would also float Canada’s economic boat. But shortly after publishing several things went wrong. It was revealed that the Canadian economy had contracted four months in a row, with the last month coming as a complete surprise to the BoC. Today, news got worse that Canada has had a record trade deficit, and combined with other bad news gives weight to the likelihood that Canada is already in recession. While this will add pressure for a rate cut, the real message here is that the Canadian market is far more dangerous and volatile than many investors think. That’s something that Canadians reviewing their portfolios should be highly aware of as they consider their retirement nest eggs.

I’m So Tired of Europe

hu·bris

noun
  • excessive pride or self-confidence.
  • (in Greek tragedy) excessive pride toward or defiance of the gods, leading to nemesis
Who doesn't want to love this place? AMIRITE?
Who doesn’t want to love this place? AMIRITE?

I love Europe. I love it’s culture, its cities and architecture and the pace of life. I think in many ways Europe seems more usefully progressive, with things like public transportation and even energy. But god I am tired of hearing about Europe. Since the beginning of the financial crisis Europe has become the wounded, but never dying, member of some ill fated expedition. Every time the expedition seems likely to escape their fate, Europe goes and breaks an ankle…or something.

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From an investment standpoint Europe makes a lot of sense. It’s the largest economy on the planet. It’s highly industrialized and very productive. It has created one of the largest economies by knocking down trade and exchange barriers between nations. It has many multi-national firms, advanced R&D, and exports much to the rest of the world. And yet it constantly represents a problem for investors.

I believe the source of that problem may be hubris. There’s not a lot of science around that statement, there is no Hubris Index to track (although that would be neat!), nor is there some ratio to calculate. But there is a pattern of behavior that seems to lend itself to such an analysis.

Caricature_gillray_plumpuddingWe should be clear though, you need hubris to do great things. Name a nation that has attempted to reach beyond it’s grasp and risen to great military and economic might and you will uncover a great deal of pride and arrogance. But something must temper that pride or what could have been great becomes the next Greek crisis.

Europe’s problem is that it seems to have little regard for the inner voice that advises caution. The Euro Zone, initially an economic endeavour to improve financial and diplomatic ties (the belief is that trading partners don’t go to war with each other) has spilled out into a messy, difficult and byzantine organization that has had a difficult time following it’s own rules. It has rapidly expanded into new markets, making it’s non-EU neighbors (like Russia) nervous about it’s intentions. It has turned countries with no business being part of the EU into powder-kegs ready to disrupt the whole experiment.

Ya, this isn't a joke. This is a real law that real people spent real time making.
Ya, this isn’t a joke. This is a real law that real people spent real time making.

Europe has lots of problems, but almost all of them are their own making. Greece may have borrowed the money that exploded their debt, but French and German banks lent them that money. Concerns that a Greek exit from the Euro could trigger a domino effect as deeply indebted nations choose default over austerity is also the  result of hubristic action. Countries like Spain and Ireland were hit with austerity because the government bailed out the banks, not because the government had mismanaged their finances.

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Europe’s desire to expand the mandate of the EU from economic integration into integration has also eroded a great deal of natural support. Exhausting, silly and pointless rules have caused nothing but ire within member states, and attempts to push through a new constitution within Europe were met with such local resistance, the whole things has been on hold.

All of this reeks of arrogance and overreach. But Europe has done this to itself, and the more we continue to hit regular road bumps on the road to financial well being, the more it looks like Europe is undoing it’s own purpose. It’s no surprise then that the economy that has recovered the quickest from 2008 has been the one supposedly worse hit. The United States has remained the foremost place for investors, safer, faster growing and more profitable than Europe. Europe, who is still dealing with the same problems of five years ago.

I’m so tired of Europe.

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.