The cost of freedom has been found. It's 130 billion euros. And in the end, this is a cost that the stock market should be prepared to bear to maintain this freedom.
Greece may soon face a very unsettling choice as it works to negotiate a settlement on its debt. German government officials are now calling for a European commissioner to replace the Greek government in directing its fiscal policy including spending and taxation. In other words, the Germans are calling for the Greeks to surrender their national autonomy. Frankly, this is an outcome that is simply unacceptable. And if giving up liberty becomes a requirement to avoid default, taking the pain that comes with default is the better option no matter what the cost.
Greece certainly did not walk alone down the path that brought it to this point. When Greece joined the euro currency union, it ceded control over its own monetary policy. In exchange, Greece became a part of a community that enabled it to borrow money at much lower rates. And borrow they did. Why did they borrow this money? In many instances, it was to buy goods from neighboring European exporters including most notably Germany. So in short, Germany gains a happy customer in Greece that is able to spend even more by joining the euro club. In good times, it appears that everybody wins. Germany increases its exports and Greece seemingly enjoys greater consumption and a higher standard of living.
Greece clearly lacked discipline by borrowing too much money during the good times, which is now coming back to haunt them. And they now must endure the hardship resulting from this mismanagement. But did the Germans or Eurozone leaders closely scrutinize Greek borrowing practices when the economy was still thriving? Absolutely not. And were Greece's borrowing practices discouraged at all by its Eurozone partners while the economy was still humming along? Once again, no. After all, exporters such as Germany were directly benefiting from Greece's additional spending, no matter how they got access to the money.
But now that Greece is collapsing under the weight of too much debt, vicious scrutiny and heavy blame has descended upon it. Does Greece bear responsibility for borrowing too much money that they were never going to be able to pay back? Absolutely. But do Germany and the European Union also bear responsibility for allowing the situation to go unchecked for so long and spiral out of control before finally doing something about it? Absolutely.
When you invite someone into your club, you simply can't reap all of the benefits of their excessive behavior and then blame them for the costs when you did nothing to curb this behavior along the way. It goes without saying, when it comes to borrowing money, it is best to act prudently. Whether you're a country, a company or a household, you should almost never borrow more than you can afford to pay back. And if you do, measures must be in place to swiftly correct this behavior before it spirals out of control. Both of these principles have been lacking in the Eurozone for many years, and it has now finally boiled to the surface not only for Greece but also several other nations across the region.
So here we are today, and it's all come down to this. Greece needs at least 130 billion euros in liquidity to avoid insolvency. Included among this is an upcoming 14.5 billion euro debt refinancing that must be completed on March 20. Surrendering fiscal sovereignty is now being offered up as a precondition for receiving this money. But here's the problem. Even if they receive this latest rescue package, Greece is never going to be able to pay these loans back in the end. Their economy lacks both the size and the growth potential to make it work. Therefore, giving up fiscal autonomy to receive more liquidity still only postpones the inevitable insolvency. Good effort to this point, but it's just not worth it anymore.
It is at times like these that tough decisions must be made, and the right decision in this case is for Greece to finally default, as giving up fiscal autonomy is simply not an option no matter what the cost. When presented with such a price, it's time to just get on with it already and default.
Give Me Liberty AND Give Me Financial Death!
A default would be a tremendously painful experience for Greece. An exit from the euro currency and a reintroduction of a new drachma would be a likely. This new currency would immediately devalue sharply and would likely have little value outside of Greece. Domestic inflation would likely spike higher and unemployment would most certainly rise sharply. Such are the costs of having borrowed too much money in the past that cannot be repaid. But by finally accepting this insolvency outcome and effectively ripping off the bandage, Greece will move more quickly toward an economic resurrection.
The economy will live again, and it will do so in a better, healthier form. It will take some time, but it will come much sooner than continuing on the current path of hopeless austerity. Most importantly, Greece as a country and as a people will maintain their autonomy. And the rest of the world will also benefit by diverting precious resources toward more productive pursuits than proving endless liquidity to insolvent countries.
A Look Across The Ocean Shows The Way Out
One has to look no further than Iceland to see what Greece might expect from accepting a default. In late 2008, Iceland simply had no choice but to sustain the immediate direct hit of crisis head on. They were not part of any currency union, and the magnitude of the bad debt in their banking system was multiples in size relative to their economy. Facing an insurmountable problem, Iceland allowed its banks to fail and effectively went into default. And a very difficult period of economic pain followed that included skyrocketing inflation and unemployment. But by accepting this pain right up front, they were able to begin working to restore their economy in the aftermath.
Where is Iceland now just over three years later? The economy is resurrecting itself and an economic recovery now appears fully underway. A deeply devalued currency has enabled Iceland to boost growth through exports. The employment picture is also improving. And the country has already regained its investment grade credit rating and is once again accessing credit markets to borrow funds. While far from perfect, both current conditions and the outlook are vastly better today for Iceland than they are for Greece. And their sovereign independence was never in doubt along the way.
It could be argued that allowing Greece to default encourages more irresponsible behavior in the future. Perhaps this is correct, but that will be for future creditors to decide, not other sovereigns, when the time comes that the country wants to try and borrow money again. In the meantime, enduring the painful economic correction will be enough to remind the Greek people of the importance of maintaining fiscal responsibility once their economy is restored to working order.
Finding The Cost Of Freedom In Stocks
A Greece default would likely place heavy pressure on global stock markets. But what is the alternative at this point. Suppose Greece is rescued from default at the cost of surrendering its autonomy. Should we believe that other countries are not far behind in stumbling down the same path? After all, Portugal may soon arrive at a similar end sooner rather than later at this point. And what of Ireland, Italy and Spain? Or even France for that matter?
Will more European commissioners be installed to direct fiscal policy for nations all across the continent before it's all said and done? Will the people of any of these nations be at all comfortable with such a prospect? I think not. And how much more must healthy economies be infected in trying to rescue those that are beyond repair anyway? Widespread social unrest is a far greater dilemma than declining stock prices.
So what could we expect from global stock markets in such an episode? The immediate downside for stocks could be significant. Much of this pressure would likely come from the European banking system, which will be forced to liquidate assets in order to absorb and manage the losses associated with this bad debt. This would likely lead to a spillover effect into the global banking system. And in some cases, banks may even fail. But the potential for such bank failures argues all the more for getting on with the cleansing process now.
Nobody wants a complete collapse of the global economy and its financial markets, so all the more reason to deploy the precious remaining capital resources toward supporting ailing banks today while cleansing the system instead of acting in vain by propping up sovereigns that will never be able to return this capital in the end. The more we can get out in front today and direct the process while controlling the damage associated with the cleansing process, the better.
Stocks would eventually bottom following such a cleansing process. But they would likely bottom at a level that would make much more sense from a fundamental perspective than where they trade today. And a stock market based on fundamentals instead of stimulus driven euphoria might even encourage the return of many investors that opted to walk away from stocks in the last few years out of sheer frustration by trading activity that too often did not make sense.
It is also important to remember that attractive investment opportunities will continue to exist even in the face of crisis. Selected areas of the market outside of stocks would likely perform exceptionally well during such an unwind scenario. Leading among these is U.S. Treasuries of all durations including long-term U.S. treasuries (TLT), as capital takes flight toward perceived safety. Agency MBS (MBB) would also likely hold steady and provide a yield premium relative to comparable duration U.S. Treasuries.
Both gold (GLD) and silver (SLV) would also likely perform exceedingly well following the initial liquidation phase of the unwind process due to their safe haven characteristics as hard assets and currency alternatives. And not every stock would necessarily be taken down by such an unwind scenario, as a selected group of stocks have demonstrated the ability to generally hold steady if not even rise during periods of extreme stress over the last few years. Representative names include Family Dollar (FDO), McDonald's (MCD) and WGL Holdings (WGL).
Now is the time to get on with the corrective process. Sovereignty must not be sacrificed for the sake of avoiding default. And if we have reached the juncture where this outcome is even being mentioned for consideration, then now is the time to take the medicine and get on with the cleansing process. If countries must leave the Eurozone in the process, so be it.
Continuing to throw money at countries that will never be able to pay it back is not a solution. And the benefit of keeping the stock market artificially inflated for a shrinking number of participants seems hardly worth it now that national sovereignty is coming into question, particularly when investor confidence in markets seem to be deteriorating anyway.
Instead, allowing these wobbling economies to undergo the corrective process and letting the system cleanse itself is a solution. Will it be unpleasant? Yes. Will it take time? Yes. Such are the cost of the excesses that came to lead us to this point. But these costs are worth it if they can help countries maintain their autonomy while at the same time working toward a new dawn and true fundamental basis for growth not only for Europe but the world. And it is conditions such as these that a genuine bottom can be established in global stocks and a new secular bull market can finally get underway.
Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.