Greek Debt Is a Liability, Not an Asset

 |  Includes: EUO, FXE, IEV, UUP
by: Glen Bradford

Let it be known: Greek debt is a balance sheet liability, not an asset.

You heard me correctly. If you think that by buying Greek debt, that the net result is that they owe you money -- I challenge you to think again. With this perspective in mind, the implications are vast and devastating to the crowd that makes their investment decisions based on the global growth hypothesis.

A Simple Analogy

I was trying to explain the situation to my friend the other day, and I was able to come up with a story that gives visibility into how things are. Imagine you have a friend in high school that has a history of never paying people back when he borrows from them. Regardless, you decide to let him join your club, and he is allowed to borrow $1 per day to buy goodies from the vending machine at school. Anyway, this is cool for a while. Occasionally this friend pays you back some interest, but the principal balance begins to grow. When he owed you $5, it was his problem. Now, you're finding out that he owes you over $100. At a certain point, the systemic problem is not him, it's your inability to assess risk. The interest payments on his loan are now greater than his allowance and he'll never be able to pay you back and you know it.

The club is the European Union and your friend is Greece. You unfortunately owe to the club the balance of his payments and cannot make good on those unless he makes good on his, which is impossible, and as such you cannot cut him off because that would expose your insolvency too and you like being the banker. What is theoretically a debt of $100 has actually now become a discounted cash flow situation where you pay your friend increasingly greater payments the longer this game of extend and pretend continues. Discount the cash flow of any asset and it should be positive. Assets produce cash. Liabilities consume. Greece debt is a liability, not an asset -- if you just look at the cash flows.

Yes, this argument suggests that astute investors should go as far as to be willing to pay people to buy Greek debt from them, because it produces negative cash flows. It's hilarious to me that Greek debt has a positive trading value. Pretending is fun, and so is daydreaming -- but eventually you wake up.

Key Takeaways

  1. Biggest Loser: Germany. Who loses when Greece defaults? Frankly, the systemic risk that is out there is more like dropping a card onto a house of cards instead of dropping a brick onto a pile of bricks. The biggest loser in Europe is Germany, because when Greece defaults, I'm anticipating that this will start a chain reaction of renegotiating. Who wants to be left out on renegotiating better terms if better terms are available? Nobody. Spain, Portugal, Ireland, and Italy are "on deck." In fact, I wouldn't be surprised to see one of them go first as the pressure continues to build.
  2. China GDP Shrinks. Odds are that the reported numbers don't show this, but I would recommend looking at electrical usage statistics out of China to see the real story. Perhaps interbank liquidity is another key statistic worth referencing. China has continued to emphasize the importance of the eurozone solvency. "Whether the European economy can recover and whether some European economies can overcome their hardships and escape crisis, is vitally important for us," Fu said. Chinese leadership has been setting the tone for what is about to happen on a grander scale.
  3. Banks Are Undercapitalized. Finally there's some good research out there. What is weird to me is that the VIX isn't as high as what I'd expect it to be, given the fact that the put/call ratio is at all time highs. I've previously covered a few specific banks that I've even advised investors to consider withdrawing money from or avoiding business with. Bank of America (NYSE:BAC) apparently is junk-bond rated if you reference the CDS markets.
  4. The US Wins. The US sure has a lot of systemic risk tied to the situation, but as the eurozone experiences crisis and China experiences unrest and other growth/inflation issues - which will mostly be hidden behind firewalls and epic quantities of propaganda - where are you going to put your money if you are a billionaire? I'm thinking that the United States looks pretty good by comparison. In the intermediary, however, the dollar should continue to outperform the euro and I am still short oil prices, even though I believe in peak oil.

Disclosure: I am long UUP, EUO.