Monday, January 30, 2012

It's The Economy Stupid: Greece Is The Word (again)

This piece is written by David Zervos (a Greek) who knows a thing or two about the Greek economy and the political machinations that are occurring about the Greek economy.


----- Original Message -----
At: 1/30 10:09:09

Before diving into the latest chapter of the Greek debt saga, some housekeeping is in order. First, our database was somewhat overwhelmed Friday with around 3000 client requests. It is going to take a few days to get the master distribution list configured, so in the interim commentaries will be sent per the normal route. For those that did not see Friday's message, we will be moving to a non-forwardable commentary distribution structure. Any client who wishes to continue to receive the notes must go to the following link and fill out the required information.

The second bit of housekeeping relates to our Global Macro Speaker Series event from last week with Marty Feldstein. We had a very strong turnout with about 150 folks for lunch in NYC. I will send out a recap of the discussion tomorrow, focusing on Marty's answers to the 10 questions I posed during the discussion. I know many folks were anxious to see his responses, but given the twists and turns in Greece over the last 72 hours, I thought I would focus attention there this morning. So without any further delays - here are some thoughts on the latest chapter in the Greek saga:

This past weekend the German economy minister and chairman of Merkel's coalition partner the FDP, Philip Roesler, openly called for Greece to surrender control of its budget in order to continue receive EU aid. In addition, there is a German produced document circulating amongst senior EU leaders which proposes a new EU "budget commissioner" who would have veto power over spending and tax decisions by the Greek government. Both the EC and the Greek government came out "strongly against" the proposal. But the German move has not gone unnoticed.

Of course, such a maneuver should surprise no one. Greece has been fighting off a hostile takeover from its neighbor to the north for centuries. From 1830s to the 1860s, and of course in the early 1940s, Germany directly controlled the country.

Statements from the German minister like this will surely generate acrimony and hostility across the Greek population. It will also jar some very painful memories. And this all kicks off as we head into the critical March 20th debt payment and PSI decision process. As the German politicians pour gasoline on a Greece that is already burning, there is really no hope for a harmonious solution. Greece will not and cannot pay its debts - just like in 1826 and 1932 - and the Germans have seemingly decided that they can quarantine the German financial system from the hard default fallout. As Karl Pohl said at the beginning of this crisis, the only reason the Germans have been paying bailout money is to protect their banking system. With the EFSF, ESM, LTRO and the stress tests in place, German policy maker confidence has grown. They have built a German TARP and TLGP structure so now is as good a time as any to pull the rip cord. Listening to Merkel in Davos it sure seemed like she was ready. So let the games begin.

Remember, the Europeans have yet to unleash defaults on their financial system. They have successfully instituted a "help for homeowners" program for their subprime borrowers - the PIIGS. Three 100b plus bailouts have stopped a Greek, Portuguese and Irish "foreclosure process". The SMP staved off a similar fate for Italy and Spain. But the coupon payments can only be paid by creditors for so long. Eventually the piper must be paid. And he who pays the piper gets to call the tune - which of course will be ""Deutschland, Deutschland über alles".

So how will this go down? Here is the most likely sequence imho –

- The EU leaders will not resolve anything today.
- There will be a PSI deal announced shortly and risk markets will rally for a few hours/days.
- But the take up on the PSI will not be enough and the deal will fail.
- The Greeks will reintroduce a CAC clause and the CDS will trigger.
- There will be a private sector default and the ECB will not participate.
- The fallout will quickly create "realized" losses at many European financial institutions.
- Bank funding will start to freeze, risk markets will dip and Portguese markets in particular will suffer significant losses.
- The Fed will quickly react to stave off any contagion to US financial institutions which could include the reintroduction of some funding facilities and an MBS QE3 program.
- The ECB will be less reactive but ultimately the Italians (with plenty of American pressure) will force the Germans to acquiesce. The ECB will backstop what remains of the European financial system with an LTRO structure that takes in pretty much any non-Greek or Portuguese asset that is on any non-Greek or Portuguese bank balance sheet.
- The "EMU 15" will then introduce a Eurobond structure and stronger but unenforceable fiscal discipline structure is agreed across the zone.
- Eventually strains will arise but the shedding of 2 PIIGS will be a short term positive for EMU.
- The Cypriots will also be at risk but the Russians will step in to keep them alive

Of course there are many possible permutations to this roadmap, but the baseline idea is fairly simple - a smaller EMU and massive policy stimulus. The risk asset dip will be short lived and those playing for chaos will have difficulty covering. Long risk + levered long blues, golds or Agency MBS should work well through the messy times.

Finally, I thought it would be useful to put some perspective on the history of German intervention in Greece. This is very important because Greeks continue to see themselves as part of Europe. They want to be European. But the German actions over the last 72 hours will play VERY poorly in Greece. It will not appear to the Greeks that they joined a "European" Monetary Union, but instead it will look like they made a Faustian pact with a very familiar foe. In any event let's go back to the history books for a moment –

Otto, a 17-year prince from Bavaria, was named King of Greece in 1832 after an 11 year battle against the Turks. He was installed by the UK, France and Russia who had financed the Greek uprising against centuries of Ottoman control in the 1820s. Of course, Greece defaulted on 600m francs of war debt in 1826, and part of the reason a monarchy was established was to get some cash back. However, King Otto was eventually exiled in the 1860s with no cash to show for his efforts. He also failed to convert Greeks from Orthodoxy to Roman Catholicism. He did however leave a nice palace which now houses Greek Parliament as well as a fancy square - "Constitution Square" or "Syntagma Square" - which is where the protests against his rule began. King Otto was adamant against the creation of a Greek constitution.

As today's title suggests the EU "budget commissioner" will look a lot like King Otto returning to Athens (singing that familiar German song). The motives of the Germans have become clearer by the day, and Greek politics is set to ignite a very ugly election period. The 2 far left parties (KKE and SYRIZA) are already calling for an early election and an end to the technocratic (German installed) government. The most recent KKE statement reads something like this – "it is up to the working people to upset their plans and to punish the accomplices severely. Class organization, popular alliance. Counterattack everywhere. Down with the parties of plutocracy. Out with their troika associates, disengagement from the EU with popular power that will write off the debt". At the same time Samaras is chillin in Moscow with Putin. The result looks to be a "Gazprom South" deal - Of course, hooking oneself into the Russian gas complex is a recipe for Ukrainian style outcomes in Greek politics - messy indeed.

Greece can head in many directions and the upcoming political process will be extremely complex. Of course, we would continue to maintain that the best things for the Greeks is exit, drachma reintroduction and devaluation. And playing the EU against the Russians, the US and Chinese could suit Greece quite well in the coming years. It will be a fascinating spring in the Balkans. Strap in and always remember that the Fed and ECB will be forced to act decisively as the European subprime sovereign lending losses rip through EU financial institutions.

Before I wrap up, as I wrote today's note I could not help but recall King Otto's suicide squad from Monty Python's "The Life of Brian". It's a fantastic scene with plenty of quality English/German subliminal messages that make for a great chuckle on a sleepy Monday morning - Enjoy! Good luck trading.

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