Greece Will Have the Last Laugh

 |  Includes: ERO, EZU, FXE, IEV, NBGGY, UUP
by: Chris Damas

News Friday that Greece has activated the Eurozone/IMF loan mechanism came as no surprise at all, following a day when Greek 2-year bonds hit near 11% junk status, 10 year bonds declined to yield 9% (they were 6.5% at the end of March), and credit default insurance for Greece rose to over 600 bps.

All of these market indicators screamed default/restructuring is coming. But I believe much worse is in store for Greek bondholders: Greece is going back to the good old drachma.

The only real surprise last month was that euro bureacrats and market pundits actually expected buyers to run to buy Greek paper after the vague EU bailout loan plan was announced in in late March.

Why on earth would institutional bond investors, or traders and shorts in this case, run to buy Greek paper, knowing the borrower was backed up against the proverbial wall with an imminent rollover of debt required?

The idea of a U.S. road show to convince people to buy their paper was absolute folly.

My patriotic pen had been dry for a month on the matter of the Greek credit crisis, as I felt if there was nothing good to write, better not to write it. I had hoped the Greek debt situation would improve, even though in my heart I knew this latest turn of events was more probable, if not inevitable.

By the way, not for one minute do I think the Greeks should be given any free money without restrictions. I just think they should be helped without having their economy and their national pride driven into the ground due to Germany's leadership having more pressing political problems.

I really don't see political leaders in Europe doing to Britain what they have allowed the Germans to demand of the Greeks if the U.K. credit situation falters after their own election in early May. The U.K. percentage of GDP deficit and total debt exceeded that of the Greeks up until recent revisions (see below).

It seems "too big to fail" extends beyond banks to countries. Perhaps after the May 6 U.K. election and the May 9 German state election, the pressure will be taken off Greece as political pressure to make Greece "an example to the others" dissipates. But it's too late for that now - bringing in the IMF for a country means "I'M Finished!"

The most recent recipient of IMF debt aide, albeit much smaller, was another beach-laden but poor republic - Antigua. The Antiguans couldn't manage to get enough money from their super rich tax-free inhabitants and well-healed visitors to pay their bills after the Great Recession hit, so they appealed to the IMF. Greece, get to the back of the line.

The most recent crisis was precipitated when, on Thursday, Eurostat, the EU statistics branch, released a shocking message that the Greek deficit for 2009 was now the highest in Europe, at 13.6% of GDP, and even this figure could be raised again, being clouded by currency swaps they were still deconstructing.

Eurostat also indicated the estimated total Greek public debt which was thought to be at 115% of GDP would rise by 5 to 7 percent. The Greek debt and credit markets couldn't take any more of the bad news and uncertainty and capitulated.

Greek Prime Minister George Papandreou tried to soften the harsh situation by comparing Greece to the mythic figure Odysseus, stating that Greece would find its way home, just as the Homeric character did (even if it took 10 years).

No doubt the Greeks have been sailing between the infamous twin monsters of Scylla and Charibdis from the same mythical story, the former being the multi-headed market speculators plucking and devouring their public funds, the latter a whirlpool of public/union discontent threatening to suck the country under into civil upheaval.

But if there were a character in Homer's Odyssey that Greece best represents today, it must be the tragic character Iphigenia.

KIng Agamemnon, the leader of the Greek forces on the way to fight the Trojans, had to sacrifice his daughter Iphigenia to appease the wind god Artemis, whom he had slighted, and whom his ships depended upon to blow them favorable winds to Troy. So he had his daughter killed.

German Chancellor Angela Merkel is sacrificing Greece for the supposed good of the European Union, the eurozone and the stability of the euro currency.

Sure, Greece is being offered a 45 billion euro loan package at interest rates that are still be determined. But the "strict conditions" that are going to be applied to these loans mean the Greek economy will shrink faster than the debt is repaid.

As some pundits have pointed out, the financial math doesn't work for Greece with 300 billion euros in debt increasing at an ever accelerating rate, and no sign of any big revenue generator. Many Greeks will sell and send assets abroad rather than pay onerous taxes on real estate. Or their assets are already abroad.

Coincidentally, Merkel's hard line with the Greeks increases her CDU party's domestic political appeal, satisfies her right wing FDU coalition partners, and improves her party's prospects in next month's May 9th North Rhein-Westphalia state election. She and the CDU/FDU dearly need more votes to obtain a majority.

Unfortunately for Merkel, that hard-line approach, so popular in Germany, is going to blow up in her face, if not soon, probably within a year.

Greece is being asked to swallow a big bitter pill that just won't go down, even by force. The austerity measures that need to occur to turn Greece's deficit into surplus are too large for the country's population to endure.

The EU/IMF loans will not be sufficient to turn around the Greek economy and pay off the debts, however concessionary the loan interest rates might be.

My prediction is Greece will depart from the euro area in the next twelve months, and thumb its at Merkel, leaving her a note on the pillow that it just isn't ready for a serious relationship with the Germans, or those in the European Commission and eurozone that supported her draconian policies anymore.

After all, the EU money spiggot had turned dry after the 2004 Olympics were completed. And it just isn't possible to squeeze more blood from an economic stone, which is Greece's situation after being hit by a tough recession holding mountains of accumulated debt. If this were a company, it would be Chapter 11.

On top of all this misery, the Iceland volcanic ash situation, if perpetuated, could reduce Greece's tourism business for this summer, if it hasn't already caused cancellations.

No, better to save face and withdraw while poking a stick in the eye of one's tormentor. Watch what happens to the euro in this case. I say the euro is still headed for $1.25 U.S. - not based on depreciation, but due to economic losses and bank failures holding Greek debt that will be converted to non-paying wallpaper.

A joke that went around in the old inflationary days of the 70s, when the drachma constantly depreciated against the USD, was that the Prime Minister (Karamanlis of the NDP or Papandreou Senior, I can't remember) should have been given the Nobel Prize for Chemistry for "turning the drachma into S__t".

Due to the newfound optimism over a bailout Friday, the euro rallied from its lows on the activation of the support mechanism announcement, and default spreads for the other credit-wobbly Mediterranean countries also narrowed. But I think this relief reaction is another example of false optimism.

The two Cassandras of the future of the Greek economy did not bring such an optimistic message: the Greek stock market, with the General Index now solidly below 2,000, stayed in a funk after failing to rally over 4% (it was at 1,945 at one point), and closed at 1,858. And the National Bank of Greece (NBG) stock dropped to a one year low of 11.17 euros with over 9 million shares traded, before rallying slightly at the close.

The other Cassandra, the striking public and private unions, raised the spectre of even a greater shut down of the country, their ire reaching even higher peaks.
According to Kathimerini newspaper, a spokesman for the civil servants' union ADEDY warned that further demands by the IMF would trigger a "social explosion".

These signals foretell the depth of the economic contraction that Greece will experience, and the social insurrection that will occur, if Greece is forced to go on the approved "G-IMF diet" that is probably in store for them. The dispassionate and ice-cool Northern European bureacrats at the Commission and the European Council don't really understand Southern European anger, but they will soon.

When will Papandreou and his PASOK government move from acquiesence with the EU/IMF, to eventual defiance? I say outside within the next 12 months - but probably sooner, perhaps by the end of the summer.

You see, Greeks are anarchists at heart. They like to disrupt authority. And they may smile in an adversarial situation. But watch out if the adversary crosses a line and pride has been hurt.

I think Merkel really has crossed that line recently, repeating the comments that the loans would not be subsidies and would come with "strict conditions" - rather insulting to continue to frame the people who have swallowed their pride to ask for help as shifty and not to be trusted, even as their shortfalls have been aired to the world for several months now.

I know most of this is posturing in advance of the May 9 election. But if she had been a tad more generous in her comments, I think things would have turned out better.

Even though leaving the euro currency area would longer-term be cutting off their noses to spite their economic faces, and I believe Papandreou is inherently a cautious man, the Greek population will pressure Papandreou's government to do it. It is in their nature. The Greeks don't like to be told what to do or not do, period.

Unilateral withdrawal from the euro and reinstatement of the drachma by Greece would cause several years of credit isolation. The Russians only just now have reissued an international bond, twelve years after their 1998 credit default.

But a cessation of debt interest payments and a conversion from euro to the drachma and effective devaluation would give Greece a big boost in exports, improve national accounts and cash flow, increase tourism industry dollars and employment, as well as give them back control over their own destiny.

No longer would Turkey and other cheaper currency venues eat the Greek tourism lunch which had been the hallmark of Greek success.

The Argentine defaults and the Venezuelan devaluations are roadmaps as to what the Greeks will have in store for them if they go down this path.

High inflation - overnight crude oil and other USD denominated commodities will be priced higher. All imported consumer and industrial goods will be immediately higher in price unless companies choose to cut prices to gain access to what is a small market.

High luxury and import taxes to support domestic spending. Before entry into the European Union, the Greeks charged as much as a 200% import tax on luxury cars. The PASOK party always had a predilection for taxing the richest.

Corporate economic dislocation hard to quantify - what about all the foreign companies with subsidiaries in Greece? What about all the Greeks employed by foreign companies that will now be losing money in Greece?

Greek banks and companies with foreign assets. These assets will suddenly look more valuable and help to repair balance sheets that will be recast in drachmas.
Companies such as OTE, the national telecom company, have investments in the Balkans and other surrounding countries.

Capital controls likely as there would be a rush to put assets offshore. It wasn't so long ago that one needed special permits to buy USD in Greece. In fact, declaration of currency exchanges is still required by tax authorities.

Central Bank: Would the Greek central bank have foreign reserves to use to stabilize the new/old drachma currency? Greeks (and not a few expatriate Germans) will wake up to find their savings worth dramatically less.

The National Bank of Greece would again have to be activated to manage the currency and monetary policy as opposed to the Greek membership at the ECB.

Whether the Greek pullout from the euro currency monetary zone deteriorates the credit default spreads for the other "PIIGS" countries will have to be seen.

The worst case scenario for Greece from a withdrawal, either partially (from the eurozone), or completely (from the EU) has Germany remorsefully becoming more compliant to the other high debt/deficit players. Turkey gains access to the EU with Greece no longer a major impediment to the Turks getting acceptance.

So Greece might become a pariah in Europe.

Or a test case for Italy to consider similar action (117% estimated total debt of 2010 GDP), Belgium (101%) or Portugal (85%).

Alternatively, the right wing factions in The Netherlands were quite fed up with the EU paying for Greece, so perhaps other potential defectors will reaffirm their commitment to the Maastricht Treaty.

And whatever happened to Agamemnon? He was murdered by his unfaithful wife Clytemnestra and her lover Aegisthus, upon his victorious return from Troy.

Disclosure: no position in the euro.