Greece vs. EU: Will the Euro Survive the Crisis?

Includes: ERO, EU, FXE
by: Daniel Moser
The EU is in a serious dilemma over the Greece situation, and to exacerbate matters even more, Portugal, Italy, Spain, and Ireland are on the horizon with similar problems that need major overhauls. Some critics, including George Soros, question whether the euro will survive this crisis.
It seems fair to suggest that a solution that requires help from outside the EU calls into question the very existence of the EU, at least in its current form. I would go so far as to say that in the event the EU does not solve these problems internally, the damage and fallout might be irreparable.
At this point the ability of the Greeks to solve their problems is extremely unlikely. According to The Economist on April 8th:

In the six months since the Socialists were elected, spreads have jumped by more than two percentage points. Greece can no longer risk holding an auction for a new issue of bonds for fear that it fails. Its Public Debt Management Agency has resorted to syndicated-bond sales managed by big international banks. But the pools of spare cash that Greece can tap seem to be drying up.

Faced with a limited ability to raise debt at a fiscally sustainable rate of interest, a population with an insatiable sense of entitlement for government spending programs, and a population that is in the top 3 most unproductive populations in the EU, the Greek government is doing what any responsible government would do … come up with some crafty debt scheme to solve their fiscal problems.
In that same article, The Economist wrote:

George Papaconstantinou, the finance minister, plans to lead a roadshow to America in the last ten days of April. He hopes to persuade American investors, including emerging-market funds, to buy $5 billion-10 billion worth of a new dollar-denominated bond. It would be a heavy irony if Greece, a member of the euro club, were temporarily reprieved by loans in dollars. But the fear is that investors will stick to buying the bonds of genuine emerging markets, which have much more solid growth prospects.

This proposal is poorly conceived. At first glance I was taken back several months to when the financial crisis contagion was spreading across Europe. Specifically, I think of the Eastern European homeowners who were convinced it was a good idea to obtain a mortgage that was denominated in a foreign currency (in their case the euro or the Swiss Franc) only to find their mortgage payments blow up in their face from currency revaluations. In this case Greece is the homeowner and the US investors would be the sneaky mortgage lenders putting the homeowner (Greece) in a risky situation because they didn’t think it through.
My next question is, why would an emerging market bond fund manager be interested in Greek debt denominated in dollars? Greece doesn’t seem to be the most desirable investment location for EM bond managers or they wouldn’t be faced with rapidly rising interest rates to begin with. Secondly, in the event the EU cannot swallow all the problems facing the weakest links, the euro could decline dramatically, potentially causing Greece to default on these bonds anyways. This would play out as they operate on the Euro. If the Euro suddenly devalues against the dollar, it could prove very problematic for Greece to generate the necessary funding to service the interest payments.
This proposal might be the Greek Plan A at this point, which is scary because “It is not yet clear what Greece’s fallback plan will be if American demand is weak.“ The roadshow will be decisive. If it doesn’t fly, the alternative is either "a wave of T-bill issues at very high interest rates, or a rescue package,” says a senior Greek banker. Mr. Papaconstantinou insists that Greece does not plan to fall back on support from the EU and IMF. But he also accepts that the government cannot go on borrowing at such high interest rates.
I would be fairly surprised if there was sufficient demand for this product from EM bond fund managers. The interest rate couldn’t possibly be that much higher or it would defeat the purpose of the Greek government to begin with.
In the book by Steven Drobny, “Inside the House of Money,” Yra Harris is quoted as saying, “the markets are like water. They will flow to the weakest point that they can push through, and they always do. It’s like an omniscient force saying, “F—you, I’m going to teach you a lesson, there’s nobody bigger than me.” The Greeks could be setting themselves - as well as any EM bond fund managers who actually participate in this proposal, and even the EU itself - up for a severe lesson in market humility.
In this situation the euro is an extremely risky currency and suffice it to say, the path of least resistance seems to be downward with no end in sight until Greece, Italy, Portugal, Spain, and Ireland are handled for good. Or at the very least a few of these country problems are handled sufficiently to restore global confidence in the EU/euro as a well thought out idea.
Disclosure: Author long eurodollar futures