Tuesday, February 19, 2013

Was I wrong about Greece, Spain and Portugal?

Two years ago now I stated that Greece and Spain were in a world of pain and about to default...boy was I wrong.  The problem with "short" views (this company is going bust next week) is that the market can fool you and things can last a lot longer than you can hold the position.

First question:  Was my position wrong?  Well since neither Greece or Spain have gone under clearly my position was wrong.  However, and this is a biggy, I was wrong in timing but maybe not in overall consequence.

For Greece the pain of restructuring is evident everywhere, yes bond rates have become tighter -- that's more a reflection of Europe's decision to do "everything in its power to keep Greece within the EU".  My problem was underestimating the willingness of politicians to spend other people's money to support their ideals -- because at the end that's the fundamental issue here.  The politicians in place (and the bureaucrats)  are willing to spend the future of Germany to support their ideal of a unified Europe, and a single currency.

Greece's  reality is that there are only three exit strategies: because the easiest (inflation) is simply not available to the country (e.g. devaluation).  The first, and most likely is default -- in other words once debt rises beyond 200% of GDP (they are now around 171%) then all bets are off, as the European central bank will then virtually all of Greece debt.  This would be followed (or preceeded by an exit if the Euro Zone) by default by Greece -- a massive wealth transfer from Germany to Greece (please note that the transfer already took place -- we are talking of bookkeeping here).  The second option is deflating the economy -- the pain is uneven and it is a very long -- this would seem to be the current (and favoured) solution as it keeps all restructuring costs  in Greece (at least until the revolution!).  The third option is European wide inflation -- extremely unlikely as virtually no country seems to be able to get inflation going (look at Canada -- core inflation has dropped to 1.2% per annum -- the BoC is looking for 2.5%).

Now, the reason for making the Greeks pay is simple -- its their fault; yes the bankers were stupid to lend them money, but it is the Greeks who lived (and not all by the way) beyond their means.  This solution calls for the entire burden of restructuring to be borne by Greek wage earners, and not savers since the savers have their money in Euros.  I'm not going to bet on this solution to work out -- because if you are Greek and smart, you will leave the country -- further increasing the burden on those who remain.  I give this solution a 50/50 chance of success -- the last European country that saw that kind of "squeeze" on the middle class was Germany -- that didn't end well for Europe.  I'm not saying that Greece will be taken over by the Nazi (but several radical Greek parties have been doing well of late).

Why this strategy may fail is that the Greek economy continues to contract, and its not so much the debt that is rising, but the GDP that is falling!  Estimates are that the debt/GDP figure will stabilize at 177% of GDP in 2013 and 2014 but these are projections:  who knows how realistic these are... after all the Greek government is prosecuting its chef statistician for being too truthfully!

In Spain its a different tune, but same rhythm!  The problem is that overall sovereign debt is very large,  and the economy is in free fall (not only is the central government cutting, but so are states and the local government), since the government accounted for more than 50% of the economy, the pain has been great.

Overall I still think the European monetary union is doom to fail, but it probably will not be Greece, Spain or Portugal that will be the trigger, it will be something as stupid as Cyprus that is in real trouble but is so small that it will be forgotten!  they will provide the blueprint to recovery.  Throughout economic history governments have defaulted against their loans -- either directly or via massive inflation -- it is ridiculous to think that things would be different now


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