What Should Greece Do?
From time to time, one of my friends simply says it better than I could ever imagine saying it myself. I have known Peter Gianulis, manager of Carrelton Asset Management for years. He is one of the deepest thinkers I know of when it comes to the markets. His fund also happens to have one of the best track records out there. So without further ado, I turn the microphone over to my good friend Peter Gianulis.
Can’t Pay Your Debts? No Worries, We Will Lend You More
The complete absurdity of the Greek (soon to be Irish, Portugal, Spain, Italy, Japan, U.S. etc.) debt crisis is beyond any rational explanation. Let me make it simple. The Greeks cannot, nor should they attempt, to pay their debts. Just get it out of the way and move forward. The perverse truth is that the European Bailout is NOT a bailout of Greece or other PIIGS, it is a bailout of the German, French and U.S. (yes, the U.S. due to credit default swaps sold to the European banks) Financial System. The real issue is whether this will be a one-time event or will lead to a series of managed defaults by a host of countries? The other question is what will happen to the Euro as a single currency?
The Greeks (and many other European countries) have “passed the point of no return” with respect to austerity measures. The levels of public debt (depending on how you measure, over 150% of GDP) are so large that the cost of servicing that debt (at whatever interest rate that you chose) is virtually impossible. When you force severe austerity measures on a population it historically has REDUCED government revenues not increased them (this is acutely true in Greece where the Government represents close to 50% of expenditures/GDP). Generally, revenues drop more than the spending cuts that have been enacted (in the short run). In other words, it is virtually impossible to balance the budget required to halt any further debt accumulation.
If I were Greek (and fortunately I can say that I am with pride), I would default or credibly threaten to default without haste. The default would force all of the creditors to the table to negotiate but now from a weaker position (they would have nothing if the Greeks don’t want to negotiate). Many pundits will argue that Greece would not be able to finance their debts or borrow any more money. EXACTLY! Freed from the shackles of the catastrophic debt load, they could now implement severe austerity measures required to balance their budget; it would not be optional as no rationale individual/institution would lend them any money. Lovely.
Greece would undoubtedly be kicked out of the Euro monetary system and would most likely go back to the drachma. Greece would once again become affordable to tourists and they would flock to Greece to see many of the beautiful historical sites, culture and beaches the country has been blessed. The days of paying €800 euros/night for a mediocre hotel in Mykonos would be over. Opa!!!
By defaulting (or the credible threat of defaulting), Greece actually improves their negotiating position not worsen it. I would immediately default on all government obligations, raise the retirement age, cut social programs, simplify the tax system and create new business tax incentive programs to create a “safe tax haven” for new European businesses willing to operate in a European country without the shackles of the Euro. Also, the fact that you cannot borrow more money in the international markets would be the best news; you are now forced to live within your means.
Greece (representing less than 5% of European GDP) is not large enough to even register a “blip on the screen” in terms of world economies or markets; so why all the fuss? It is our belief that a Greek default would legitimize the concept of government defaults from European or “Developed” Countries and most likely lead to a series of defaults (far larger than Greece) that would roil the financial markets and world economies for years. The European Central Bank (as well as the FED) is acutely aware of this draconian scenario.
The easier trade, in my belief, is the Euro. I cannot legitimately conceive of any reasonable scenario whereby the Euro appreciates in value versus major world currencies. The most likely scenario is Monetizing or Defaulting. Monetizing, or printing more money, would require a change in the European constitution or “playbook.” The first step would be for the ECB to assume the bad debts of the member countries and financial system. The second step would be to print more money. Not a good scenario for the Euro. The second scenario is an outright default and likely expulsion of Greece from the monetary union. This would invariably lead to other expulsions and a likely break-up of the monetary union. Even worse scenario for the Euro.
As we discussed in many of our monthly commentaries in 2007-2008, the much-expected assumption of private debt by the government (read: public) is now “front and center.” There is no hiding from this tsunami of paper and debt. The next few years will undoubtedly be one of the most interesting financial and economic times since the Great Depression. We are going to try to enjoy the ride!
Good luck and good investing.
