Greek Default: What It Means For Investors

by: John Lindauer

There are a number of things for investors to consider now that Greece is certain to default on its sovereign debt and go off the euro. Here's the checklist with some short conclusions.

The first and most important is whether the new government Greece will have in the near future keeps Greece in the the EEC (European Common Market) after it officially goes off the euro. Yes for sure.

The second is what the exchange rate will be between the new Greek currency and the euro once the dust settles and whether the rate will be pegged or allowed to float. About 2:1 and effectively allowed to float.

The third is whether the Greek people and businesses will continue to use the euro in their everday economic activities as opposed to a new currency such as a Greek Euro or a Greek Drachma. Greek business and banking will continue to be euro-denominated.

The fourth is which countries will follow Greece off the euro and how soon. Portugal? Ireland? Italy? Maybe Portugal immediately and then no new departures for about a year.

The fifth is the fiscal condition that Greece will have after the default. Is it true, as has been reported, that the Greek budget will have a slight surplus when its debt service is eliminated? Yes. This will enable Greece to offer new bonds in its new currency. And they may be good value for investors.

The fifth is how soon after it defaults will Greece issue new bonds and how good they will be. Almost immediately.

The sixth is how Greece will handle its existing sovereign debt held by the IMF, ECB, and the "rescue fund." Will Greece pay some of it? Yes, but they will end up taking serious haircuts.

The seventh is the steps the Greek government will take to protect the Greek banks and pension funds which are now holding large blocks of sovereign debt. It will totally protect them.

The eighth is what Greece will do for everyone else holding its debt - the large German banks, the estate of MF Global, etc. Absolutely nothing.

What's going to happen and what it means for investors

It's a good bet that Greece will meaningfully guarantee all Greek bank deposits and CDs, all its pension payments, and most of its life-time jobs; and that it will continue to pay interest on that portion of its current debt held by Greek banks and other financial intermediaries. In other words, the Greek government will protect the Greek people. No surprise there.

It's also a good bet that the new Greek government will not use the default to implement the major tax and regulatory reforms that might attract jobs and businesses to Greece. Any group of politicians so dumb as to force their economy into a serious depression to save the banks that loaned them euros is too dumb to make the necessary changes to get the economy back to prosperity and full employment.

Another prediction is that Greece will end up offering "political cover" to the leaders of the Common Market by "paying off" its current IMF, ECB, and "rescue fund" debts with non-interest bearing bonds with no due date. Few, if any, of these will ever actually be repaid.

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 once the default is official.

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 is to consider buying the new bonds the Greek government will almost certainly issue. They will probably have a high coupon and Greece will not default a second time because it will have its own central bank.

A third suggestion: Buy and sell in the expectation of similar swings in stock and bonds and gold, comparable to those that occur when Greece goes down.

Investments in Europe

In the long run several things are likely as defaults occur and countries leave the eurozone. One is that the biggest losers from the defaults will be German shares, bonds, and banks - all of them. Germany will continue on the euro so each departure of a weaker euro member will mean the euro is undervalued at its then-current exchange rate. 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 and less profitable.

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 fourth suggestion: each time a country looks to be leaving the eurozone short the shares of German and the remaining eurozone exporters and buy German bonds.

The other thing to watch carefully is the reforms retained by the defaulting governments when they announce their defaults and departure from the euro. 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 fifth suggestion - and it's the most important: Investors and traders should particularly watch the back stories as it is likely that some of the defaulting countries will use the default event to introduce major economic reforms such as dramatically reducing taxes and regulations to attract business. This, particularly when coupled with the resulting appreciated euro, will attract German and other Common Market employers to relocate to the defaulting countries which make major pro-business reforms as part of their fight to stay with the euro. All the more reason to buy the stocks and bonds of their businesses and the Greek businesses that will benefit from their presence.

My sixth suggestion: carefully watch the euro's exchange rate and 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 countries leaving so that the euro strengthens, and others will really take a sales hit.

Conclusion

If Greece does go off the euro it will almost certainly stay in the Common Market - then Greece and its now depressed companies and banks will boom relative to the countries remaining on the euro.

The increase in activity in Greece will occur because property and businesses will be cheaper to buy in euro and dollar terms. If Greece actually implements the reforms it promised when it was trying to stay on the euro, 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 reforms and the absolutely certain major depreciation of the euro/Greek exchange rate.

Because jettisoning its euro debt and introducing pro-business reforms will be good for any country leaving the euro, immediately following the initial announcement might be a good time to buy Greek shares across the board. Similarly, it could be a good time to buy the shares and bonds of those companies and banks which are likely to expand in Greece to take advantage of its increased economic activity and lower costs.

At the very least, immediately after Greece defaults and again has its own currency will be a great time to visit Greece - because everything will be so cheap in terms of dollars and euros.

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