Things are changing rapidly in Europe as the euro block continues to move towards a partial disintegration.
This week, for the first time, Germany was unable to sell all of its bonds and most of the rest of the euro countries could not sell any at all. That’s the result of uncertainty and not surprising because most investors and traders have not yet figured out what’s going to happen. So money moved out of the euro and into safe and not so safe havens such as the dollar and gold. Look for the dollar and the price of gold to rise.
More significantly, the European Central Bank reiterated that it would not buy Greek, Portuguese, and other sovereign debt. Those countries will not be able to refinance their existing debt as it comes due. The ECB's refusal to buy is in keeping with its charter which specifies its sole goal is to prevent inflation. It means the big European banks which booked profits by making high interest sovereign euro loans to Greece and other soon-to-default countries are going to take a hit – unless they have sold the loans off to US and other hedge funds such as MF Global.
Much more significantly, the ECB has signaled it will move beyond its inflation-fighting charter and buy assets from eurozone banks to provide them with liquidity so they can weather the resulting losses from the sovereign defaults. It made no such commitment to help MF Global and other current holders of the soon-to-effectively default Greek and other debt. They are going to take serious haircuts – unless they are bailed out by the governments of their own countries.
Even worse for the current holders of the debt, Germany and France will undoubtedly arrange for the coming “defaults” to be called something else and structured such that they do not trigger credit default insurance claims. Increasingly, as I suggested a few days ago, it looks like it will be a “voluntary” exchange for non-interest and non-maturing certificates that will never be paid. If not, there will be at least a very serious haircut.
Does that mean every holder of sovereign debt is in trouble? No. Each country will determine for itself whether or not to bail out its non-bank institutions such as pension funds, insurance companies, and any other institutions. Whether they do so or not will vary from country to country.
So the question then becomes what happens to Greece and the other countries which default?
First, without a doubt they will all stay in the Common Market but remain, as the UK is, outside the euro zone with their own currency. If I had to predict, I would bet that some of them will call their currencies euros – the Greek euro, Portugese euro, etc, just as a number of countries today call their currency the dollar – the US dollar, Canadian dollar, etc. That will reduce the inconvenience because, it some cases, it may enable local euro-denominated transactions and contracts to remain in place. For example, a labor contract or pension or mortgage in Greece calling for the payment of 2000 euros per months will now be payable in Greek euros (expect a lot of lawsuits).
Second, the exchange rate between the euro and the new euros and new other currencies will depreciate the value of the new euros and other new currencies. They won't exchange 1 for 1 with the euro. So investors with dollars and euros are likely to be able to find some real values in Greek properties and equities.
Similarly, if the value of the new euros significantly below 1 to 1, German and other euro-zone manufacturers will find it more profitable to produce in Greece than in Eastern European where they are now going, both in those countries that remain on the original euro and those with their own currencies that have exchange rates fixed against the euro.
Where will the exchange rate between the new Greek currency and the existing euro go and how will it swing over time? I wish I knew. My best wet finger in the wind is that it will initially end up at about 3:2 to 4:2.
Will Greek government attempt to set a fixed rate between its new currency, whatever it is called, and the euro? Quite likely – because the IMF will undoubtedly offer Greece money to do so in order to restore a role for the IMF bureaucracy and give it an excuse raise new money from naïve national investors such as the US and Saudi Arabia “to help Greece and ease the current crisis.” I would place the odds of this happening at 90/10.
The odds are even better (99:1??) that the countries which already have money and those who put in more money “so the IMF can help Greece” will never see the money again - because for cultural reasons if the Greeks again have a source of money to spend without taxing themselves or freeing their economy from its serious governmental restraints, a new crisis and new default is only a matter of time. The difference being that, again with IMF help, the Greeks will be able to devalue but this time without going to a new currency – perhaps to 3:1??
With the IMF money and its new exchange rate, the Greek economy and its banks and its real estate may boom. On the other hand, Germany and those countries that remain on the euro will see the exchange value of the euro rise, as the euro zone’s weaker members depart, such that companies remaining in the euro zone are increasingly priced out of export markets. Whether that helps or hurts companies in the euro zone will depend on the elasticity of demand for their products – for example, losing 20% of your customers in Greece because your prices have increased 50% due to the new exchange rate would mean you are taking in 30% more money and having lower costs because you are producing less. Your revenues will rise. On the other hand, losing 80% of your customers because your prices effectively increase 50% means your revenues decrease.
In other words, the time has come for investors to look at Greek properties, move out of German and euro zone stocks of companies that are heavily into exporting price sensitive products to buyers outside the euro zone, and move into the stocks of those companies heavily into exporting relatively price insensitive products.