The ECB Boiler Room

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 |  Includes: EU, GREK
by: Alhambra Investment Partners

By Jeffrey P. Snider

To say that Greece is an economic and fiscal mess is to be repetitive. While the imprint of victimization stains much of the economic collapse, it is at least somewhat strongly applicable in the reminder that financialism is a huge strain in the long run. As with nearly everything European since last summer, the whispers run toward recovery even in Greece.

But this idea of recovery challenges every conventional notion of what recovery actually means. This continued usage screams for a different taxonomy, one in which words directly translate instead of euphemistically assert bias. In Greece, for example, car registrations were 347,354 in 2008; last year the country registered 78,630. This year, that number is projected (with fingers fully crossed) to actually gain, slightly. Such is evidence for a "recovery" when the word means to literally regain previous form. It may be generations for that to happen in Greece.

What is taking place in Europe in general and Greece in particular is the absence of further contraction. However, such a reprieve does not necessarily follow one to the other - contraction to recovery. As should be more apparent given the Japanese example, indeed the American example, there is a less detailed but more relevant decay into which this absence of recovery belongs. Namely, these economies do not recovery but simply experience a phase shift to a lower plateau (hopefully a plateau).

This wistful clemency has only encouraged more of the same financialism behavior. At the end of March, two of the ruling coalition parties of the Greek parliament were "forced" to expel one member each for not supporting a vote directing further reforms aimed at securing still more IMF and EU aid. That leaves the coalition with a margin of merely two seats - and only then because six members of the Golden Dawn party have been arrested and are awaiting trial.

According to Reuters:

The passage allows Athens to obtain loans to repay 9.3 billion euros of debt maturing in May, but left the fragile pro-bailout government with a new headache as three deputies refused to vote or voted against key articles in the bill.

In other words, there is tremendous political risk attached to the ability of Greece to repay debt, not the least of which is external. And that repayment itself is almost akin to a sanctioned check kiting. With another looming election, that can only rise, particularly with the opposition parties raising their standing in the polls.

Against that political backdrop, despite predictions of that recovery in GDP of 0.6% this year (coming after a 25% drop over six years), the financial system is still reeling. Loans and credit creation continue to fall (another European commonality).

According to BoG data, net cash flow to the domestic private sector February 2014 fell by €773 million, shrinking 4 percent, year-on-year, as it did in January.

The net flow of funding to businesses, in February 2014, retreated by €439 million, while the annual growth rate remained steady at -5.2 percent, as per January 2014. Funding to non-financial companies February 2014 fell at an annualized rate -5.1 percent, up from -5.3 percent in January. The funding net flow also retreated by €353 million. The funding to insurance companies and other financial institutions also dropped at an annual -7.1 percent, dipping steeply from -4.1 percent in January.

That has left the rest of the Greek economic complex in a more than precarious position. All of which adds up to a tremendous amount of risk not just with the private sector, but the public sector as well. Yet into all that political and economic uncertainty the government there is about to float a bond offering of five-year paper. The expected yield on the €2-€2.5 billion issuance is about 5.25%-5.5% (terms depend upon who is doing the estimating).

That is more than astounding given the risks attached. Greek bond yields have been steadily dropping ever since Draghi's promise, but it strains reason to see new Greek bonds trade to the same yield as that of Hungary, Dominican Republic or even Sri Lanka. All three of those countries hold higher ratings than Greece (though the "big" news is that Moodys might upgrade Greece to less junk status), but far more importantly none of them have defaulted in the past three years. The Greek government managed to do it twice.

Investors have such short memories whereupon the "reach for yield" is all that matters. Nations that default so spectacularly usually are shut out of bond markets for more than just a calendar turn or two. The difference, of course, is the ECB. With that implicit/explicit guarantee, bond investors have bid any and all debt under that umbrella without much regard to any realistic sense of risk. This is even more basic than arguing over whether recovery exists or not - in other words the Greek economy may well have stopped contracting and found a bottom, but that does not erase the high risk attached to any credit derived therein. The most basic foundation of finance is risk/reward, yet here we have it completely obliterated.

There is a term in finance for when an intermediary openly and actively entices investors to ignore all means of sense in order to purchase the securities of a very risky prospect without inhibition: pump and dump. Greed is not good; it is a monetarist tool.