... And the Growing Default Risks that Come With It
"The world´s financial markets seem obsessed with daily monetary and fiscal policy evolutions in euroland which form the basis for risk on/risk off days in the marketplace and the overall successful deployment of carry strategies so important to asset market total returns. Euroland is just a localised tumor, however. The developing credit cancer may be metastasised, and the global monetary system fatally flawed by increasingly risky and unacceptably low yields, produced by the debt crisis and policy responses to it. The great white whale lies on the horizon. Investors should sail carefully." ~ Bill Gross, "A whale in the waters of negative yields," Financial Times, May 14, 2012
We are amidst an economic phase of volatility and sequential recessions followed by quasi-recoveries. We have titled this overall economic scenario a "Reflationary Debt Trap." I expect this scenario to hold for the coming months.
In my view, European leaders will attempt to hammer out a fiscal union in the upcoming meetings, or at least some form of a "declaration of intent to install a fiscal union," with all the possible bells and whistles that might come with it. The promise will be received positively by global financial markets.
Likewise, in the US, quantitative easing is clearly back en vogue with the Fed. The much awaited FOMC (Federal Open Market Committee) meeting fell short of expectations for another round of outright quantitative easing but saw an extension of Operation Twist to the end of 2012. Ultimately, the Fed's actions are headed in the direction of more monetary expansion. The economy will be propped up at all cost, at least until the presidential election.
Economic indicators have been mostly on the soft side (housing starts, jobless claims, Philly Fed, home sales). Meanwhile, in Europe, deteriorating conditions are starting to affect the German engine, where several indicators – including the ZEW Indicator of Economic Sentiment and the Manufacturing Purchasing Manager Index (PMI), to name a few – disappointed. And then, in China the preliminary PMI came in lower than expected, prompting fears of a sharper than expected slowdown of the Chinese economy.
All this will lead to more monetary intervention. And with all the concerted government action, you might expect another quasi-recovery in the coming months. However, I strongly recommend you keep your cautious stance in place and, if you decide to speculate in a potential stock market rally, that you have a disciplined risk management system for downside protection in place.
Target2 – Just one example of big-scale accounting shenanigans in support of the house of cards in Europe.
Germany is under growing pressure to finally join the spending bandwagon and give up its chosen path of austerity, balanced budgets and monetary discipline. In fact, the aggression versus Germany is growing in a time when Germany is really the last stronghold of the overall EU and Euro system.
On the surface, monetarists and Keynesians are quick to call for "more money" as the only panacea. However, the fact is that things are much more brittle and fragile than assumed. Even though Europe fiscally is, in fact, in better shape than the US or the UK, even in Europe, all kinds of technicalities and accounting shenanigans mean the picture painted by mainstream media is distorted and imprecise.
Last November, in this context, I wrote an article titled "Lost in the Greek of It." In it I discussed the Euro Crisis, its mire of political gibberish, and the nonsense of bureaucracy that comes with it. Today, I am very pleased to share an article that follows, provided by Fredrik Hanssen, a young and talented economist from Norway, on the topic of TARGET2.
TARGET2 – standing for the Trans-European Automated Real-time Gross Settlement Express Transfer System – is but another of those mythical acronyms we encounter in the context of the daily economic mumbo-jumbo in the news. It is yet another accounting-based credit facility, another means of supporting the house of cards that the Euro zone has been built on.
It is truly worth reading Mr. Hanssen's article and understanding how TARGET2 works. It is important to understand not because it represents a particularly relevant piece in the puzzle but because it is an excellent example of how far we have progressed on the smoke-and-mirror path of monetary, fiscal and regulatory nonsense.
Playing along in the Greek Version of Monopoly
We've all played the board game Monopoly at one time or another. The basic goal of the game is to play until all opponents are bankrupt... the winner takes it all! However, at times, a kind-hearted mother may give her child some her funny money just to extend the game a little longer and keep her child happy. A generous player may give his friend and opponent, a bankrupt Monopolist, a funny-money loan. Or, the bank might be robbed in joint consent, in the interest of harmony or the fun of the game. The rules might be adjusted, softened, or contorted to help.
This is where we enter the realm of the "Greek version" of Monopoly. In this version of the game, one where the rules are not strictly adhered to as agreed in the beginning, one where "social goodness and solidarity" outweigh the rules, the game of Monopoly can take forever. In fact, in this mode, the winning player that has all the money (i.e., the Germans...) might be considered over-ambitious and ruthless, particularly if he does not show a little flexibility.
You get the picture. Greece is currently again in that precise mode. Greece has slipped behind budget-cutting targets that the euro-area nations and the IMF imposed in exchange for the 240 billion Euros in aid pledges in the past two years. Furthermore, it appears that Greece will push its creditors to extend fiscal deadlines under the country's bailout program by at least two years, according to a policy document drawn up by the three parties in the country's governing coalition. The Greek government also requested a freeze on public-sector redundancies. Under the loan agreement, Greece had promised to reduce the state payroll some 150,000 civil servants by 2015, including 15,000 job cuts this year.
Since 2010, Greece has received a total of EUR 347 billion in aid – two loans of EUR 110 and 130 billion each and a debt write-down payment of EUR 107 billion. This amount is equivalent to one-and-a-half times the country´s GDP or EUR 31,000 for every Greek citizen. A two-year extension would mean a further loan of around EUR 20 billion in 2015, as Greece is still unable to borrow on financial markets.
At the time he relinquished power in May, Greece's "technocrat" Prime Minister Lucas Papademos had drawn up a list of 71 points to be dealt with before June to meet the conditions laid down in the memorandum. According to a European expert, around 60 of these items are still outstanding. Greek GDP is on course to plummet 7% in 2012, having fallen by a cumulative 10.2% in 2010-2011, unemployment has now reached 22.6%, and the state coffers will be empty by mid-July unless they receive yet another emergency top-up.
And so global investors remain focused on Greece, where it is believed that a messy exit from the euro zone will potentially rattle the world economy. Truthfully, Greece´s economy is like the pimple on an elephant´s butt: It´s irrelevant in the big scheme of things. However, the media has decided that it´s a great story to tell.
In my opinion, what is most relevant for us as investors in the context of the developments around Greece, the euro, and the current global economy in general, is the enormous level of arbitrary rule-bending and government-orchestrated bureaucratic shenanigans. Rule of law is long gone. International treaties and agreements are not worth the paper they are written on.
Promises and rules will be broken at the whim of a bureaucrat's pen, all in the interest of extending this game of Monopoly a little longer.
Frank Suess is CEO and Chairman of BFI Capital Group. To subscribe to BFI's weekly Mountain Vision Update, in which this column appeared, click here.