Tuesday, March 31, 2015

A bet!

Last week I made a bet that Greece would be out of the Euro by March 20th 2017.  Within 24 months Greece will be gone from the Euro.  All those around the table thought I was insane, what I wanted was for a $1.00 bet, very much like in the film Trading Places.  Due to pressure the bet got a little bigger -- but again nothing outrageous.   So today March 31st, 10 days after the bet was made where do things stand... well not so good for those thinking that a solution will be found.

The Greek Prime Minister indicated to the Greek parliament that negotiation were not going well, and that the country was quickly running out of cash to pay interest on the debt it owed to the ECB that the country owes for April 2016.  Well have a look at the graph below:

Greece is concerned with April, well look at the summer's refinancing obligations!  The truth is that Greece's problem is intractable, in February, the ECB gave Greece 4 months of fresh  money, most of it was used to pay interest on loans and the balance was used to help emergency supports that Greece's poor now need.  The reality is that Greece still thinks it can BS its way out of trouble.  The truth is that the government has undertaken minimum reform because there is still no real drive to make changes. Also true is that Greece simply cannot repay all its outstanding loans.  

One stop gap measure would be, like for Cyprus, for Greece to introduce capital controls, negating its participation in the Euro for everyone but rich folks and companies involved in export and import. Limiting the amount of cash that can be drawn from banks (hence the recent absolute destruction of Greek bank's deposit base), and imposing the right of seizure for any amount exceeding $5,000 (or what ever amount they choose).  It would mean that Greece would remain in the Euro zone. Greece would not have left the Euro, but would be exclude from the Eurozone for ordinary transaction.  

Lets not forget that Germany still wants all its money back -- is it a political decision or a negotiation tactic? its not clear at this stage.  One thing for sure, the German public has been led to believe that Greece can and will repay its outstanding debt. [no one mentions that the reason Greece owes so much money to the ECB and IMF is that German bank's and pension funds (also French banks) were bailed of their Greek debt exposure].  The currency control will only affect the average Greek -- who lives from his salary, rich Greeks have already taken all their cash off-shore in Swiss, German or Austrian accounts.   At any rate currency control are unworkable, yes in the short term it could help reduce the outflow of Euro, but in the long run people find ways around the controls.

So what's next?  

There are no easy solutions here, Greece has to change -- and despite the tremendous pressures facing its politicians and its people it is hard to see a willingness to accept that the system is deeply flawed and must be changed.  As long as they can, young bright Greeks will leave their country, the brain drain is already massive -- if you are smart, you know you have to leave, anywhere is better than Greece right now.  An exit from the Euro will be very difficult and painful for many many years.  It will not be all sweetness and love for the rest of the Eurozone.  Spain, Portugal and Italy will become the next targets -- the market will be hungry for other prays once Greece has fallen -- and if the ECB lets Greece goes you can bet that the market will be looking for easy money.

However, an exit from the Euro would allow the necessary changes to the economy to occur less painfully, since inflation could be use -- something the ECB and the Deutschbank would never allow within the confines of the Euro.  

That's why I remain confident that Greece will exit the Euro:  Germany and the ECB in general are unwilling/unable to accept the write down necessary for Greece to remain in the Euro, and Greece simply cannot repay or modify its economy within the current status quo...finally, the market seems to agree with me:

N.B. Now like any tool, credit default swaps have to be used with a great deal of care, since it's effectively an unmatched bet.  You can sell insurance without having a position in the underlying debt -- you just write a CDS.  

Overall, the market has not been this pessimistic since 2011 when the crisis first emerged -- and where the vast (if not all) majority of Greek's debt was held in private hands (today its around 20%). But yields have jumped from 500 bps to nearly 2,000 bps since September 2014.  

Wednesday, March 4, 2015

Another rate cut overnight -- what do Central banks know?

Conventional wisdom says that the global economy is on the mends -- some will point out that even Greece is doing better, and so the big riddle remains; If the world is doing so well why are interest rates falling?  Last night another central bank cut interest rates (Israel in this case).

The total so far for 2015 is 20!  Over 20 central banks have cut interest rates.  Yes inflation is flat (almost everywhere), but its not in the gutters yet.

There is virtually no discussions about this anywhere in the financial press.  What is concentrating the market is the number of central banks (and high rated banks in Europe) that have begun charging interest on deposits.  We now have a world that charges for deposits and pays for loans.  There is something fundamentally broken in the system.  The more I think about it, the more I am convinced that the bond guys have got it right, Zero is not the lower bound for interest rates.  There's still some juice left in that game -- the smart money is in medium duration bonds -- taking further advantage of the tax discrepancy between cap gain and income.

The implication of this has to be that central banks (and their governments) are extremely concerned with the global economy and are not seeing fundamental growth.  So what's going on?  One bet could be the quality of job creation -- either at minimum wages or close to, and jobs that require little or no skills.  As an example, 20 years ago, when buying a stereo (higher end unit) you went to a store and spoke to a guy who knew his stuff.  Today you don't, the best computer/stereo store in the world J&R Computing closed its doors in NYC last year.  They could no longer compete with the buying guides available on the internet.

Another clue; this morning's announcement that RBS was firing 3/4 of its investment bankers (yep, 14,000 out of 18,000) are being let go.  What was interesting is that a large part of these cuts will come out of back office -- that will be automated...

The amazing thing is that this has not happened yet.  I've seen the tools available to F/X and Interest Rate clients for nearly a decade.  A treasurer is able to fully automate his cash flow's F/X positioning using tools available from several banks to make sure there are no errors, and then getting the best bid -- in effect the treasurer has become his own trader, because these trades are actually automated (so that back office is also automated).

The impact, in one bank, 90% of traders were let go, as was 95% of the back office (this was done over time, quietly) -- what was left were complex trades that require both a trader and a back office to understand the trade -- this is profitable for the bank, and very cheap for the treasurer.  Now, RBS made a splash out of this natural decision (any news to detract from the bank's horrible performance), but it remains that the City of London's back office will be decimated over the next two or three years, the same for Wall Street -- we are looking at hundreds of thousands of high paying jobs that will disappear -- never to be replaced.

These facts are starting to scare central banks, for while CB's didn't care unduly about manufacturing job (I'm exaggerating here) white collar jobs is another issue entirely.  They are much higher paying (a good back office manager will earn STG 55,000 to STG 90,000 per annum) and these jobs are not being displaced elsewhere they are disappearing.  Traders too are being replaced by 24/7 intelligente trading machines (think High frequency traders), that don't need much pay and don't bitch either.

Now if we could just find a good software to replace the CEOs... the world could be perfect!  No workers no jobs, all the profits to the shareholders.  Piketty's vision would be complete 100% of the benefits of economic growth would go to capital.