By Joseph Y. Calhoun
The analysts streaming across my screen last week all had the same opinion – Greece will vote yes, accept Europe’s terms and stay in the Euro. Well, as I write this, the early polls prove, if nothing else, that one should beware of experts bearing consensus opinions. According to the headlines at all the major newspapers the Greeks have voted OXI to more pension cuts and tax hikes. Certainly Greece’s creditors want to get paid but the terms of the deal on offer – well actually the deal expired at the end of June – were unlikely to accomplish that goal. It was a recipe for continued economic pain with little hope for gain. Greece, like much of Europe, needs pro-growth reforms and neither the current Greek government nor its creditors have produced a plan that even attempts to do that.
The immediate concern for investors is what happens now and even knowing the outcome of the vote it is difficult to predict. Germany and the leaders of Europe face a very difficult choice, with nary an appealing option. On the one hand, Greece could default on their Euro debts and go back to the Drachma. Their creditors, which are mainly European public institutions such as the ESM, would be forced to write down the debts. And since they are public institutions, that means the public would take the hit. Theoretically at least, European governments would have to issue debt to cover the losses, including recapitalizing the ECB. If you think European QE is having a positive effect, a Greek default would all but neuter it as it would be used to buy up the bonds issued to cover Greek losses.
The other option is for Merkel to soften her terms and let Greece stay in the Euro. While this option is certainly appealing to the Greeks – and maybe even some of the European governments who don’t want to eat a Greek default – there are risks here too. The concern with Greece from the beginning has been contagion, that a Grexit would travel from Greece to Portugal to Italy to Spain. I have my doubts about that and merely easing the terms of Greece’s bailout could just lead to a different kind of contagion. Certainly if Greece gets the easy payment plan, Portugal will be wondering why they can’t get relief too. Personally, I think Europe would be better off getting what they can from Greece and letting them go. I suspect Greeks would quickly regret going back to the Drachma with no credit line to fall back on. But I also think that is unlikely and the message it sends is that it is the debtors who are in the driver’s seat not the creditors. That is a dangerous realization in a world awash in debt.
We won’t know for some time I’m sure which path Europe and Greece will take and in the meantime, markets will be trying to adjust to the new reality. I don’t know any more than anyone else what the outcome of that adjustment will be. The consensus is that it is a big negative for markets but I can’t help but wonder if the consensus will once again be wrong. Greece is not a large country and represents a small percentage of even the European economy much less the global economy. If the entire country shuts down – which it almost has already – it will hardly be noticed economically. As for the Euro, ask yourself which currency you want to own, a Euro with Greece or a Euro without Greece? I think the latter is probably certainly a better currency. The next few weeks will certainly be interesting if nothing else and I doubt the excitement will be confined to Greece or the continent. Markets can take bad news, they can take good news. What they don’t handle very well is uncertainty and Greek voters just added a big dollop of doubt atop global markets.
Back on this side of the pond, we’ve got our own problems and our own Caribbean Greece. I suspect, with no proof, that last Monday’s 300 point sell off was more about Puerto Rico than Greece. To my knowledge US direct exposure to Greece is nil. But Puerto Rican debt is a different story with municipal and high yield bond funds owning a big portion along with some hedge funds who are undoubtedly leveraged. A default or restructuring by Puerto Rico will cause real losses to US investors.
If the US economy was growing at 3 or 3.5% the Puerto Rico and Greece problems would likely be shrugged off with no problem. But that isn’t our reality; growth has been 2 to 2.5% for several years and the first half of this year looks considerably lower. One can’t help but wonder if the “new normal” of slow growth is actually downshifting rather than preparing for takeoff as the Fed presumes. With productivity growth turning negative and work force participation continuing to make multi-decade lows, it certainly isn’t out of the question. And then a shock like Puerto Rico and/or Greece looks more ominous. It certainly shouldn’t be enough to push us into recession but market psychology is a fragile thing.
The first half of the year ended with a whimper, US stocks and bonds both offering almost no return and foreign markets offering better results but with, as we now know, a lot more risk. With a global economy that is already slowing – at least the US portion of it and that probably means everywhere – the twin shocks of Greece and Puerto Rico mean the second half is starting with a bang. Or is that 4th of July fireworks I hear?
The euro fell sharply on Monday (local time) in Asia-Pacific trading following the news.