“Wisdom is nothing more than healed pain.”
Robert E. Lee
The euro situation is going from bad to worse, and the effects are spilling over to the U.S. and the rest of the world. The EU’s inability – or lack of desire – to address the issues at hand when they had the chance has contributed to this mess. Instead of coming up with a concrete solid plan, they opted for short term fixes and kicked the proverbial can of worms further down the road, hoping that by some good fortune/ingenuity, the situation would remedy itself. This proved to be wishful thinking, and now the can is so heavy that the mightiest kick barely has any effect. D-Day is fast approaching, and the ECB and top members of the EU are no closer to a solid plan than they were two years ago.
Greece is struggling to convince the world that it has its debt under control, but hardly anyone seems to be buying this line. It is now estimated that Greece’s chance of a default is 98%; no amount of reassuring seems to have any effect on the markets. The cost of insuring $10 million of Greek debt has soared to a new record of $5.8 million.
Greece‘s stock market has shed over 33% in the past 7 weeks, and the yield on its 2 year note is now at a whopping 70%. In response to this, the euro is trading at new seven month lows against the dollar and it hit a 10-year low against the yen.
Some of the top members of the EU, like Germany, are reluctant to release additional funds because Greece is having a hard time meeting the deficit requirements that were set. This is something they should have woken up to right at the beginning; instead they sought to throw good money into a black hole, in the hopes that Greece would get its act together, despite knowing otherwise. Once the debt to GDP ratio exceeds 100%, very few nations have the capacity to swing back to the black. With a GDP to debt ratio in excess of 140, Greece is toast.
Now German officials are hinting that Greece might have to endure a so called “orderly bankruptcy” to put an end to this crisis. Is there such a thing as an orderly bankruptcy? A default will most likely make the euro look less attractive and put more upward pressure on safe haven currencies such as the Swiss franc and Japanese yen. This, in turn, will force these nations to intervene in the currency markets to stem the rise of their currencies, propelling the currency wars to the next level. Eventually, it could push one of these nations (Japan is the prime candidate) to peg their currency to a weaker currency. Taking the high road no longer pays as these nations are discovering, for all the leading economies are overtly manipulating their currencies – the lead player in this case being the U.S.A.
Without these emergency loans/handouts, Greece will soon run out of money. The Greek prime minister has stated that they have enough money to pay their debts until October; other experts state that they could run out of money before the end of the month. The whole bail out process was nothing but a bank rescue operation in disguise, and the disguise was rather pathetic. No one bails out the little investor when he makes a mistake, and the same should hold true for these banks. Why are they paying their analysts in the millions if they cannot distinguish a bad investment from a good one? French and German banks have the largest exposure to Greek debt as shares of their big banks shed in excess of 10% on Monday. Greece is the Fannie Mae of Europe – an investment whose only function is to lose money.
All of a sudden, the much hated U.S. dollar has become a safe haven currency; the dollar has exploded upwards in the past few days. Yields on 10-year notes continue to drop to new lows; the current yield is 1.93. The Treasury sold $32 billion of 3-year notes at a record-low yield due to concerns that Greece is moving closer to a default. The 3-year note is yielding 0.33% (negative yield when inflation is taken into consideration), and the 30-year bond has a yield of 3.24%. The bond market is a bubble waiting to pop as such yields are simply unsustainable.
Chancellor Merkel seems to have little faith that Greece can avoid a default, stating yesterday that decisions taken in July by European leaders “won’t suffice” to save Greece from missing a payment on its debt.
Greek Default.com notes that the General Secretariat for Information Systems (GSIS) has just published a detailed list of the corporate entities that owe more than €150,000 in tax arrears. There are 6,000 companies on the list with arrears of €30.9 bn. 10 companies alone owe €4.4 bn, with train company OSE leading the way; the top 100 companies owe €11.7 bn. Of the 6,000 companies with arrears, 212 make up 50% of the total.
The publication of this list will certainly create pressure, but with tax collectors on strike it remains to be seen if the publication of this list will help with the collection of taxes. The Wall Street Journal states that thousands of Greek tax collectors and customs officials walked off the job Monday in the first day of a two-day strike over plans to cut civil service salaries, the latest in a string of protests over Greek government reforms. They were joined by taxi owners, who have called their own two-day walk over plans to liberalize taxi services, and garbage collectors in the capital, Athens, who are staging a separate 48 hour strike over local government cutbacks. “The participation rate in the strike is over 90%,” said Yiannis Grivas, head of the tax collectors’ union, or POE-DOY. “The workers are striking to protest the looting of their income.”
Increasingly, it appears that Greece is Europe’s Lehman brothers and just as the Feds let Lehman sink, the Europeans are increasingly eying this possibility. With yields on two year notes at an astronomical 70%, a shrinking economy and tax collectors on strike, the odds are slim to none that Greece is going to be able to pay of its debt. The repercussions could be huge, because banks will instantly have to write off these losses. If not handled properly, this could lead to a run on the banks and could also impact funds in the U.S., which hold European debt.
Inadvertently, the ECB might/could find itself in the position of having to guarantee French, Belgian, Spanish and, possibly, German debt. If handled properly, such a dire outcome could be avoided. However, this is a topic for another article. One possibility would be for the ECB to guarantee virtually every part of the financial market like the Feds did back in 2008. The Fed, Treasury and the FDIC guaranteed everything commercial paper, money-market funds, bank deposits, asset-backed securities, etc.
The situation is not that rosy in the USA. The US is broke, instead of allocating money to create new jobs via new infrastructure projects. Trillions have been spent on propping up the stock market. The quality of life for the average American has not improved in the past two years and the job market remains as tough as ever. The situation in Europe could spill over here and the US could also soon be singing the blues. Economists have already dropped their growth forecasts for 2011 and 2012.
In their latest forecast, top economists with the National Association for Business Economics predict that the economy will grow 1.7 percent this year — down from the group’s May prediction of 2.8 percent expansion. For 2012, the group is forecasting growth of 2.3 percent, compared to a May forecast of 3.2 percent growth. “A wide variety of factors were seen as restraining growth, including low consumer and business confidence,” said Gene Huang, the president-elect of NABE and one of 52 professional forecasters who participated in the survey. “Panelists are very concerned about high unemployment, federal deficits and the European sovereign debt crisis,” said Huang, who is chief economist at FedEx Corp (FDX).
Bank of America (BAC) has stated that it’s going to slash its workforce by 10%, eliminating 30,000 jobs. This is only going to increase the number of unemployed and make it even harder for those already seeking work to land new jobs.
The EU is between a hard place and a rock; they cannot simply continue to pour money down a black hole. 90% of Germans are completely against any future bailouts/handouts and 85% think that banks should be allowed to bite the bullet for their foolish investments. Allowing Greece to go through a so called “orderly default” might not be the best option. Throwing them out of the EU might be a better option.
The initial reaction will be extremely negative and there will be a huge dose of pain, but at least a strong message will be sent out to the future would-be defaulters – that they need to either get their house in order or risk the same fate. There is no easy way out and taking a half-baked approach might end up causing even more pain down the line.
In an illustration of how dreadful the situation is, U.S. Treasury Secretary Timothy Geithner will travel to Poland to attend a meeting of eurozone finance ministers later this week. It will mark the first time in history that a U.S. Treasury secretary has attended such a meeting. The sudden resignation of Juergen Stark, Chief economist of the European Central Bank, came as another shock to the markets. Shares in Societe Generale (SCGLY.PK), BNP Paribas (BNP) and Credit Agricole (CRARF.PK) were hammered again due to expectations that Moody’s would downgrade all of them as a result of their exposure to Greek bonds.
Makoto Noji, senior strategist at SMBC Nikko Securities said:
Europe is not just lurching from one crisis to another. It is lurching into a new one before the previous one is solved.
The situation in the US is not much better. Our debt is exploding upwards at an unsustainable rate. Our economy appears to be slowing down. Unemployment remains stubbornly high and so far nothing the government has done has effectively reduced the unemployment rate. At some point, rates are going to have to rise, or we are going to have to implement back-breaking austerity measures; either way, the long-term outlook is far from bright. There is simply no way that rates can remain at such historically low levels indefinitely.
In turbulent time, investors should take out some insurance. Purchase puts as a form of insurance. Better yet, take some money of the table and wait for a better time to redeploy those funds. One good timing indicator is to wait until fear levels hit an extreme; this technique will not get you in at the exact bottom, but it will help you purchase stocks at extremely attractive prices.
Investors searching for high yields can use the list of stocks published in our recent article as a guide. Traders can use strong rallies in the euro to open up positions in EUO and UUP, as the charts are indicating that the euro is going to through a very difficult phase over the next few months.
“The trouble with normal is it always gets worse.”
Disclosure: I am long EUO. These positions were opened several weeks ago.