Top German officials appear to be paving the way for a Greek end-game. The question is whether this will ultimately signify an end-game for the euro project.
According to a report in the London Telegraph, Philipp Roesler, Germany’s economy minister, said that Greece’s deficit-reduction measures were “insufficient,” and suggested that preparations need to be made for a “worse-case scenario." He said, “To stabilise the euro, we must not take anything off the table in the short run. That includes as a worst-case scenario an orderly default for Greece if the necessary instruments for it are available.”
Ominously, he warned that a Greek default would require “re-establishing the affected state’s ability to function, perhaps with a temporary restriction of its sovereign rights."
Roesler’s comments come as Germany’s Der Spiegel magazine reported that finance minister Wolfgang Schaeuble was ordering ministry officials to make preparations for a Greek bankruptcy. The report claimed the German government is contemplating two default scenarios – Greece staying in the euro or the country exiting and reintroducing the drachma.
Can A Firewall Be Placed Around Greece?
At this point, Greece is on the verge of becoming a side-show. The real issue is whether the crisis can be contained and prevented from spreading beyond Greece. All focus is now on Spain and Italy. If interest rates in these nations rise and the economies in these Mediterranean nations start contracting, they will miss fiscal targets and they will find themselves in a similar predicament that the Greeks have been in. It is widely recognized that Spain and Italy are “too big to bail.”
As suggested here, the only effective means for halting the downward spiral in Europe is for the ECB to step in decisively by promising to buy unlimited quantities of the sovereign debt of member states such that interest rates are kept at levels that are in line with long term fundamentals.
In this regard, the recent resignation of Jürgen Stark, European Central Bank executive board member, reportedly over disagreements regarding sovereign bond purchases by the ECB, could be interpreted as a sign of a lack of consensus within the ECB for a solution of this nature.
On the other hand, the resignation of Stark can be seen in a more positive light: A hard-liner is gone and this opens the way for aggressive measures by the ECB. Indeed, Stark’s resignation could be interpreted as him seeing that “the handwriting was on the wall.” Not being able to change the inevitable outcome, Stark may have decided that he wanted nothing to do with a policy he vehemently opposed.
Conclusion
A Greek default seems increasingly likely. While the ultimate EU-wide consequences are uncertain, it would be a mistake to get overly bearish in the short-term on an announcement of a Greek default. This event could be the catalyst that finally spurs the ECB to do what it should have done all along which was to contain the crisis through aggressive purchases of member state sovereign bonds.
However, if unprecedentedly aggressive ECB measures are not forthcoming, a terminal EU-wide crisis cannot be ruled out. As pointed out here, such a crisis could be magnitudes greater than the crisis suffered by the U.S. in 2008-2009.
Technically, the 1,120-1,100 area on the S&P 500 (^SPX) should be watched with keen interest. A break of this level could result in accelerated liquidation and acceleration toward my downside target area of 1,020-950.
I am watching stocks such as Microsoft (MSFT), Apple (AAPL), AT&T (T), Verizon (VZ), Vodafone (VOD) and Goldman Sachs (GS) with keen interest. These stocks all have high cash flow yield, brand name franchises, pricing power and long term growth prospects. In Europe, I am watching stocks such as Siemens (SI), Banco Santander (STD) and Telefonica (TEF) which are reaching attractive valuation levels based on cash flow and book value. However, I believe that all of these stocks will be available at prices 10%-20% lower than they are currently.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I am long SPX puts. I am short TLT and long TBT and SBND.
