Seeking Alpha
Contrarian, macro
Profile| Send Message| ()  

In a recent article, I described the Greek parliament's upcoming vote on 13.5 billion euros in new spending cuts and tax increases as a "make or break" type event for the market. Although I have attempted to explain why the coming weeks are absolutely critical for Greece, Greek Prime Minister Antonis Samaras' characterization of the two alternatives facing the country in the event of either a negative or positive vote make my portrayal seem rather meek. Recall that last week, Samaras said:

" ..The problem is not whether we [introduce] this measure or that measure. On the contrary, it is what we would do if no agreement is reached and the country is led into chaos." (emphasis mine)

So chaos awaits if parliament votes 'no' (a contention I actually agree with although I'm not sure it will happen as quickly as Samaras seems to be suggesting). Now consider what the Prime Minister predicts will happen should the new package and budget get parliamentary approval:

As soon as the new measures are passed and we get the critical aid tranche, liquidity will start again to feed businesses and households, uncertainty will end, sentiment will change... the fear of a return to the drachma will disappear...[and] all this (talk of Greece exiting the euro) will end irreversibly.

Now that is the definition of make or break. Of course it is also profoundly unrealistic. Greece will not revert to a state of nature immediately should the vote not pass and a rainbow will probably not appear over the Athens Parliament House to give the "all clear" in the event the vote passes. The fact is that no matter what the outcome, Greece will remain mired in a deep recession for years and the specter of a 'Grexit' will hang over the Parthenon for quite some time.

Take it from Angela Merkel who, in stark contrast to the hopeful tone struck Sunday by Samaras, told her Christian Democratic Party Saturday that

...whoever thinks [the debt crisis] can be fixed in one or two years is wrong.

Specifically, Merkel predicts the crisis will drag on at least until 2018.

The new projections for Greece's debt revealed last Tuesday showed that instead of topping out near 170% of GDP, the country's debt will now likely hit 192% of GDP in 2014. It is difficult to imagine that no one will be talking about a 'Grexit' past next week as Samaras predicts in the event the votes are positive.

To some, all of this talk about a Greek exit and a subsequent reverberation through the world's financial system is just scare tactics. This is easy to say from the cozy confines of a country not struggling under 25% unemployment and social and political upheaval.

In fact, according to the CIA World Fact Book, as of 2009 (so you can probably go ahead and assume the stats have gotten far worse since then), more people lived below the poverty line in Greece than in Bosnia and Herzegovina in 2007, Iran in 2007, Jamaica in 2009, and the West Bank in 2010. This point was originally raised on ZeroHedge, but it bears repeating here because the dates for the comparison countries' estimates weren't listed in their post, so it didn't paint the clearest picture as to exactly what was being compared to what. The real question here is what the figure is now for Greece if it was 20% in 2009 and 20% in 2010. If the figure has risen by just 5%, the same number of people would be living under the poverty line in Greece as in Iraq in 2008 and Uganda in 2009.

Now given this, investors should ask themselves if this situation is likely to get better or worse going forward given the new estimates for Greek debt-to-GDP. It would seem that doubts about the country's ability to remain in the euro will undoubtedly persist and while there may well be a general consensus that it would be better for the stability of the worldwide financial system if Greece did not leave the euro, there simply is no agreement as to who will foot the bill for keeping it in the currency union. As the Wall Street Journal so eloquently explains:

All creditors agree that Greece's debt is unsustainable. They also agree that someone will have to take a loss. They all insist that the said someone is someone else.

So this brings me back to the point I raised previously. Private holders of Greek debt say they will never be asked to take another haircut because the portion of Greek debt held in private hands is inconsequential as a result of the original PSI, therefore buying Greek bonds is a good idea. Eurozone governments say they can't take a writedown because it may be illegal, therefore people assert there is no reason to worry about a domino effect. The ECB says it can't take a writedown because to do so would be monetary financing, therefore the assertion is that the ECB's balance sheet is safe. Finally, the IMF is senior so it can't take a haircut - period. Nonetheless everyone seems to think that Greece will not be allowed to exit the euro.

All of these scenarios simply cannot coexist. Someone has to take a loss here - that's all there is to it. Either private creditors get hit again, eurozone governments get hit, the ECB gets hit, or Greece exits and everyone gets hit. Anyway you slice it, this isn't going to end well. Those who think the fate of Greece will have only a negligible effect on the U.S. financial system (and by extension U.S. equities) are, in my opinion, exhibiting a misplaced sense of American exceptionalism which, if they don't protect their portfolios with put options or long positions in volatility, will prove detrimental to their financial well-being. As strange as it may sound, "so goes Greece, so goes Spain and Italy." And that, readers, is where the real damage will be done.

Source: Greece And The Dangers Of Being A Financial American Exceptionalist