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.  

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