Pandora's Grecian Riddle
Pandora’s Grecian Riddle
Here’s a riddle for you. What could make the U.S. Dollar and Gold rally while keeping short term interest rates exceptionally low, in the face of a bleak domestic economy?
The answer: bigger troubles overseas finally finding their way into the light.
I have said for the last 6 months that there is big trouble brewingin Old Europe and the Mediterranean. Many of you who absorb information fromsources other than CNBC and Fox Business channel are already aware that Greeceis on the verge of catastrophe. Members of the EU met in Brussels yesterday,February 15th for the primary purpose of discussing what to do withGreece’s inability to bring their budget in line with national their nationaldebt expenditures, currently totaling about 300 million Euros. They will alsoneed to secure financing of more than 50 million Euros to maintain operationsthrough the end of this year. Currently, their deficit represents about 12.7%of GDP. Jean- Claude Trichet and the rest of the EU policymakers want thisnumber to be brought down to 4% for 2010. It is my understanding that there isa tacit agreement among members of the EU that deficit financing cannot accountfor more than 3% of GDP for EU members.
To put this in perspective, our debt levels here in the U.S. arerunning at approximately the same percentages as Greece. This would be theequivalent of the U.S. cutting its budget deficit, currently around $1.3trillion by more than $550 billion both this year and next. Can you imagine thecivil unrest this would create or, what it would mean to Medicare, welfare orsocial security? How about schools, police forces and the postal service? Thisis what the approximate proposal by the EU would cause in Greece.
Obviously, the next thought is, “its Greece. So what? How badcould it be?” Remember that we’re talking approximately 300 billion Euros.According to John Mauldin, this represents 2.7% of European GDP. Remember BearStearns? They held less than 2% of U.S. banking assets. The issue here is thatthe other members of the European Union would not have the collectivecoordination to operate swiftly and decisively in the event of contagion.Russia in 1998 had a very clear operating system. Decisions were made anddirectives were carried out. Argentina in 2002 was also able to implement thedefault, restructure, revalue and grow procedure within less than a year.However, according to yesterday’s meeting, as reported in both “The Guardian”and the “Telegraph,” there is virtually no consensus among what should be done.The mandate to cut debt was issued but, what enforcement power is there tocarry it out? How long will the other nations allow the European Union as awhole to be seen as impotent in the world financial markets?
Of course, Greece has choices. Most plausibly, they agree to EU concessions and implement them fractionally – like the teenage child that whose completion of the chore list is underwhelming, to say the least. Secondly, they could default on their debt. This would throw the country into a depression.However, unlike Russia and Argentina, who both had a wealth of natural resources to fall back on, over 75% of Greece’s GDP comes from the service sector and less than 4% comes from natural resources, which consist mainly ofagriculture. Therefore, they will not be able export their way to economic recovery the way the Russia and Argentina have. Finally, they could vote to remove themselves from the European Union. The benefits would include a devaluation of their debt and an instant competitive edge in labor pricing.Unfortunately, any savings – monetary or land (mark-to-market), left in Greece would be devalued immediately and it would leave them unable to securefinancing on the open market for quite some time.
Going back to where we started, I asked the question, “What would make the Dollar and Gold rally while keeping short term U.S. interest rates low?” As of this morning, (2/16/10), European Union leaders have broken offtalks with Greece over what to do. A Grecian default would place a huge strain on Germany, Switzerland and France, the three primary holders of Grecian debt(Mauldin). Great Britain and Spain are stuck dealing with their own problemsand the Swiss won’t get involved. If the EU were to bail out Greece, what wouldIreland say? Here in the U.S. we arbitrarily chose to save some firms and letothers fall by the wayside. Think Bear Stearns versus Goldman. The fallout was substantial. I can’t imagine the political chess game that involves picking which country to save and allowing which one to fail. From a tradingperspective, and this is about trading – not political rhetoric, this eventwill create uncertainty in the financial markets. Holders of Euros will diversify. Whether they buy U.S. Dollars directly or, simply move money out ofthe Euro and into other currencies, this action will devalue the Euro. Furthermore,this uncertainty will attract more money to Gold. Finally, uncertainty in theEuro Currency will reassert the U.S. debt markets as king, thus keeping short term rates low for the foreseeable future.Any questions, please call.