(By Darrel Whitten) Greece is at an impasse. There no longer is the political will for deep, painful austerity to meet the conditions set by the
(European Commission, International Monetary Fund and the European Central Bank) for additional funding support. Even though the country is virtually being governed by the EU Trioka, debts are higher than ever and the recession is worsening. Further, the political situation is chaotic. For months, European leaders have been trying to find a way out of the Greek debt morass, but austerity is merely driving the country deeper into economic despair. It is time for a radical rethink. The electorate in the Club Med countries as well as the Euro core of Germany and France is sending a very clear message--"We've had enough. We won't play along anymore,"…i.e., the Trioka's policies have failed, just as similar IMF policies in Asia after the Asian currency crisis failed.
The Trioka has failed to establish Greece as the first line of defense for the Euro monetary union, and are essentially preparing themselves as well as investors/traders/speculators for a Greek brankruptcy and withdrawal from the Euro, while pressuring Greece to either toe the line on required austerity measures or withdraw from the Euro monetary union.
Hardliner German finance minister Wolfgang Schäuble has said he hopes Greece remains in the euro zone but that Europe is "ready for every eventuality". German chancellor Angela Merkel has warned Greece may be forced to leave the Euro if the country refuses to implement spending cuts agreed to by the former government with the Trioka. We wonder how much of this is for local constituencies as well as the warring political factions in Greece. The German quandary is that they want Greece toe the austerity line while knowing full well the implications of a Greek withdrawal. The German public has no more patience for using German savings to save their spendthrift "Club Med" neighbors. But if Greece goes bankrupt, the German government stands to lose dozens of billions of Euros in the worst case scenario. German taxpayers share liability for potentially worthless Greek government bonds taken on by the European Central Bank (ECB) during the financial crisis. The Munich-based Ifo Institute for Economic Research estimates the cost to German taxpayers alone up to Euro13 billion. While private sector holders of Greek debt have already been required to take deep haircuts on the value of their holdings, these holdings are still "marked to hope" while realizable market values have virtually vaporized.
Given the current chaotic political conditions in Greece, even finance ministries in Europe are growing increasingly skeptical about Greece's ability to reform. After two years of fighting Greece's debt crisis with more of the same, hardly anyone believes that this strategy will work -- not in Athens, Brussels or Berlin. When asked whether he and his colleagues were losing patience with Greece, Luxembourg Prime Minister Jean-Claude Juncker, who chairs the Euro Group made up of finance ministers of the 17 euro-zone member countries, gave the curtest answer possible, saying only: "Yes." Solving Greece's problems, many have come to recognize, will likely take closer to 20 years rather than just 10. Thus Germans like the head of the
believe a Greek bankruptcy would be the "mildest possible horror scenario" for all concerned.
At a different venue, the same Jean-Claude Juncker called talk of a Greek pullout from the Euro "nonsense" and "propaganda," saying only a "fully functioning" Greek government would be entitled to tinker with the conditions attached to 240 billion euros ($308 billion) of rescue aid.In other words, the finance ministers' frustration seems aimed more at forcing the warring Greece political factions to form a stable government that the Trioka could deal with.
But the Trioka's strategy to save Greece, and by inference other Club Med countries, was and is based on assumptions that have proven hopelessly optimistic. Europe's leaders assumed that Greece and the Club Med countries would quickly return to economic growth, even though the austerity measures demanded makes this a non –sequitur. Cuts in salaries and social spending have led to a dramatic drop in demand that has accelerated the economic contraction, which in turn means plunging tax revenues, requiring even more spending cuts.
If Greece fails, Euroland banks, insurance companies and funds will try to divest their government bonds from crisis-ridden countries as quickly as possible. Meanwhile, residents from Lisbon to Madrid to Rome could stage a run on their local bank accounts and move cash to northern Europe. The gradual capital flight seen in recent months could become a true deluge that slam-dunks banks and pushes the monetary union to the point of collapse. German, French and other Euroland banks would have to permanently write off not only Greek government bonds, but also many loans made to the country's private sector. For German banks alone, Greek exposures of around €14 billion is at stake, while the figure is higher at €35 billion for their French counterparts. Some banks would not be able to absorb these losses as well as losses on other weak Euro sovereigns, and would require additional aid from their respective governments, as well as successive ECB LTROs like those already offered twice, in addition to more USD swap lines from the U.S. Federal Reserve.
Greece Goes Bankrupt But Remains in the Eurozone?
If Greece leaves the Eurozone, it may draw a clear and final line under the entire Euro adventure would be the next logical step, rather than fighting continuous crises as other countries to follow Greece. For Greece, if the government were to reintroduce the drachma, greatly devalued, it would make the country's goods and services cheaper. The tourism industry, for example, would then have a considerable advantage over competitors such as Spain. "This is the most well-proven and feasible way to overcome crises such as the one in Greece," says economist Kenneth Rogoff. EU politicians are quick to assert that Greece is a special case, but since when in this crisis have EU politicians been right? EU citizens and international investors simply don't believe these assurances.
European leaders find themselves in a dangerous Catch 22. If they go on as they have been, Greece, Spain, Portugal and others won't emerge from the crisis. If they force the weakest out of the euro zone, they endanger the entire monetary union. The Trioka of course denies this. ECB policy maker Christian Noyer, in joining ECB officials Luc Coene, Jens Weidmann, Patrick Honohan, Ewald Nowotny and Joerg Asmussen in discussing a potential Greek exit from the Euro, commented to journalists that, "Whatever happens in Greece won't be a problem for the French financial sector, I don't know a single group that will be placed in difficulty by an extreme scenario for Greece." Yet German Finance Minister Wolfgang Schaeuble is urging the Greek government to stay within the monetary union, warning that departure would trigger a crippling devaluation, all the while insisting such a scenario would be manageable.
The one viable, but expensive, strategy would be to allow Greece to go bankrupt, but within the Eurozone. This would make it possible to reduce the country's mountain of debt to a manageable level, providing the necessary leeway for a new start both economically and politically, through tough structural reforms and a growth strategy for industry and services.
Monitoring the State of the Crisis
Regardless of what EU, IMF, ECB or other "spokesmen" say about the ongoing—and deteriorating—crisis, investors will remain skeptical until they can put their finger on something tangible that is actually working to improve a steadily deteriorating situation, and regular investors that can't make big, leveraged bets with CDS (credit default swaps) and other fancy derivatives/hedges of the like that tripped up JPMorgan need some indicators to monitor the day-to-day danger level of the crisis, i.e., crisis worsening; risk off and raise cash, head for save havens, or crisis improving; some risk on but remain defensive.
a) Eurostoxx 600 Banks Index
Banks are inevitably on center stage in any fiscal/financial crisis, and the Euro sovereign debt crisis is no exception. The Eurostoxx 600 banks index is again back to the March 2009 lows hit at the height of the 2008 financial crisis (down over 80% from the 2007 high), meaning little if any, meaningful progress has been made in the balance sheet issues plauging the Euroland banks, despite repeated ECB bouts of ECB support, because the root causes, a heavy overhang of rapidly deteriorating sovereign debts and an unsustainable monetary union, continue to fester.
Indeed, Europe is making less progress than even heavily criticized Japan did during their financial crisis from 1990 to 2003, and everyone knows what happened in Japan, i.e., a massive consolidation in the banking sector, from some 17 "major" banks to essentially four too-big-to-fail megabank institutions, and the consolidation continues. It is also ironic to note that the same regulators and finance chiefs that had plenty of free advice for Japan during its malaise now find it so hard to take their own advice. It took Japan nearly a decade to clean up its banking sector. How long will it take Euroland?
Eurostoxx Bank Index: 4-Traders.com
In the case of Japan, the banks, even after consolidating into a handful of too-big-to-fail megabanks, remain the mother of all shareholder value destroyers. The stock of Mitsubishi UFJ Financial Group (8306.T), generally considered the strongest of Japan's few remaining major banks, has plunged 83% from a 2006 high, after the ostensible end of Japan's banking crisis in Q1 2003. So unless the root problems that caused the balance sheet distress in Euroland banks are solved and the banks completely write off these liabilities,we see little probability of a meaningful rise in Euroland bank stocks and indeed a greater probability of renewed lows
. b) Spain, Italy 10-Year Bond Yields
Spanish 10-year sovereign bond yields are again above 6% for the third time since July 2011 and have competed with Italian 10-year sovereigns for the highest yields during this crisis. Ten-year Spanish yields recently rose as high as 6.36%, with the risk yield premium over benchmark German bunds widening to 477bps.
Spain has remained in recession since the 2008 crisis and its banking system is in particularly bad shape. Euro ministers salute Spain's newfound resolve to clean up its banking system, but that has not alleviated the pressure on Spanish bond yields, as investors see Spain as the next weak Euro sovereign to need a bailout.
The movement in Spanish and Italian sovereigns of late suggests both are a good short. As for what regular investors could trade, however, there is the a) DB Italian Treasury Bond Futures ETN (ITLY
) that tracks the Euro-BTP futures (Italian government issued debt securities) in USD, b) the Euro Debt Fund (EU
) which consists of "high quality, short-term" Euro-denominated debt securities with a weighting tilted toward "safer" Eurozone country debt like Germany (20%), France (19%) and Luxembourg (12%), c) the Germany bond index fund (BUND), which consists of Euro-denominated investment grade debt issued by the German government and German corporates. Ironically, these three vehicles are actually up YTD, most likely because of the boost given by the ECBs late 2011 and February 2012 LTROs that as can be seen by the Italian treasury futures ETN is fast wearing off.
Spanish and Italian 10-Yr Sovereign Yields
Euro Bond Investments Flat to Up
c) Euro vs JPY, USD
Last but not least is the Euro as a pure currency play. Because of the strength of the core Euro nations and the fact that the debt position of the Eurozone in its entirety is not that bad, the Euro has actually held up pretty well in the face of all the discussion about an eventual break-up or downsizing toward the "core" Eurozone nations. But open speculation about the "inevitable" dropping out of Greece from the Euro even among the EU's finance ministers from has kicked out any props that had been holding the Euro up.
From the following charts, it looks likely the Euro will test its prior low of 1.25 versus USD before it will test its prior low of 97.5 versus JPY, and could even bounce if support at 102.5 versus JPY or at 1.275 versus USD holds. Both of these support levels however were established before any serious talk about an imminent drop-out of Greece from the Euro.
d) De La Rue: If Greece Abandons the Euro...
Euro Heading to Test Prior USD, JPY Lows
No matter what the crisis or catastrophe, there always seems to be a trade to take advantage of another's misfortune. One stock to watch as an indicator of what the market thinks of the chances Greece stays in the euro is London-listed De La Rue (DLAR.L). De La Rue is the world's largest commercial security printer and paper maker, and is by its own description "a trusted partner of governments, central banks, issuing authorities and commercial organizations" around the world. The Group is involved in the design and production of over 150 national currencies and a wide range of security documents including passports, driving licenses, authentication labels and tax stamps. In addition, the Group manufactures sophisticated, high speed, cash sorting equipment.
The stock has been spiking along with speculation of a Greece Euro exit, but given the miniscule trading volume, it appears as if only a few punters have gotten the memo...
De La Rue a Play on Greece Drop-Out