Picking Winners When Greece Defaults

Includes: FXE
by: John Lindauer

<< Back to Part II

The first two parts of this series of articles discussed the forthcoming sovereign debt defaults of Greece and other euro countries, in terms of whether Greece and the others would be temporarily bailed out once again. We discussed basic default alternatives when the bailouts end -- either absolutely defaulting or quasi-defaulting via exchanging their current sovereign debt for non-interest bearing certificates.

There are three main questions to ask now that it is certain Greece will default. Given that Greece has enough revenue to pay all its non-debt expenses with enough left over to pay some interest, the first question is whether Greece will do so with or without exchanging its debt for non-interest bearing certificates. The second question is what steps it will simultaneously take to protect the Greek people. The third question is what will Greece do for everyone else holding its debt - the ECB, the large German banks, the estate of MF Global, etc.

My best guess is that Greece will meaningfully guarantee all Greek bank deposits and CDs, all its pension payments, all its life-time jobs, and that it will continue to pay interest on that portion of its current debts held by Greek banks and other financial intermediaries. In other words, the Greek government will protect the Greek people. No surprise there.

My next bet is that the Greek government will use the default to implement major economic changes and might even move to a “free trade zone” in order to move jobs to Greece from all over the common market. Another prediction is that it will end up offering "political cover" to the leaders of the Common Market by 'paying' off its current debt with non-interest bearing bonds with no due date. Anyone who gambles on these being paid would be better off buying the Brooklyn Bridge.

The first suggestion for investors and traders: the very real likelihood that Greece will protect its own banks and their depositors, while ignoring everyone else, makes Greek Banks an interesting speculation as one of the few possible winners from the default.

Another big winner, at least initially, will be gold. There is going to be turmoil and uncertainty in the “cake walk” of the world’s financial markets until it is certain who, besides MF Global, ended up with the Greek bonds-- and thus, the losses-- when the Greeks sit down on the only remaining chair. Gold is still viewed by many as a safe haven, and there will be renewed calls for currencies to have gold “backing"-- - which won’t happen but will certainly encourage the buying of gold until reality sets in again.

The governments of other countries with unpayable sovereign debt are likely to quickly follow Greece in fairly quick succession. There will be quite a bit of turmoil, and what happens when Greece defaults will be a great template for what will happen each time a new default occurs.

The second suggestion for investors and traders: Buy and sell in the expectation of similar swings in stock and bonds and gold, comparable to those that occur when Greece goes down.

In the long run several things are likely. One is that the biggest losers from the defaults will be German shares, bonds, and banks – all of them. Germany will continue doing business in the euro block. So, the departure of the weaker euro members will mean the euro is undervalued at its current exchange rates with other currencies, such as the dollar and pound. In other words, the euro will rise each time a weak country leaves. Each time that happens it will make the exports of Germany, and the countries that remain on the euro, more pricey.

Each time the euro appreciates as weaker economies leave, the export sales from the remaining euro countries will tend to decline as a result of the stronger euro. This, in turn, will force the ECB to loosen up so interest rates fall in the euro block.

Thus my third suggestion: short the shares of German and other euro country exporters and buy German bonds .

The other thing to watch carefully is the reforms announced by the Greek and other governments when they announce their defaults. For investors and traders, these will be the very important back stories of the big news that there will be a default, probably more important than the news of the default itself.

My fourth suggestion-- and it's the most important: Investors and traders should particularly watch the back stories as it is likely the Greek, and other defaulting countries, will use the event to announce major economic reforms, such as going off the euro entirely but remaining in the Common Market and/or dramatically reducing taxes and regulations. Either change, particularly when coupled with the resulting appreciated euro, would attract German and other Common Market employers to relocate to Greece and cause the Greek economy to begin to boom. All the more reason to buy Greek stocks and bonds.

My fifth suggestion: carefully watch the euro's exchange rate in the sales of the companies in the euro block with a high percentage of export sales. The demand for some export products is inelastic, and the demand of others elastic. Some companies will not be hurt much by Greece leaving so that the euro strengthens, and others will really take a hit.

My sixth suggestion: bet on Greece defaulting but not leaving the Common Market or going off the euro.


Because jettisoning its euro debt and major pro-business reforms will be good for Greece it might be a good time to buy Greek shares and bonds across the board, as well as selectively buy the shares and bonds of those companies and banks whose profits, and thus share prices, might move up if they are likely to expand in Greece to take advantage of its increased economic activity and, hopefully, improved business climate.

If my analysis is off anywhere, it is probably in predicting that Greece will not go off the euro when it defaults. At this moment I see the odds that Greece stays with the euro at 70-30. (I see the "30" as happening if the Greek government is so desperate to pull in as many new jobs as possible from the rest of Europe that it is willing to sacifice the purchasing power of its pensioners and government employees).

If Greece does go off the euro it will almost certainly stay in the Common Market - then Greece and its companies and banks will boom relative to the countries remaining on the Euro. This is because even more German and other euro block companies will be setting up operations in Greece to take advantage of the lower costs of production, resulting from the absolutely certain major depreciation of the euro/Greek exchange rate.

Thus my seventh suggestion: buy even more Greek shares and bonds if Greece both defaults and goes off the euro.

My eighth suggestion is to respond in the same way to each succeeding default after Greece's.


I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.