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Greece Exits. Then What?

May 22, 2012 2:08 PM ET
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It's remarkable how ingenious people come up with nice sounding words which hit public chords on the head. One such, from some time ago, was "BRIC" for Brazil, Russia, India and China which now often loosely stands for emerging countries but actually captures much more than this.

Every generation or so, markets get the "emerging market" bug and investors come to believe - again, and again - that the new set of emerging markets (Asian Tigers, ASEAN, Latin America, etc) are going to explode and, genie-like, become another USA, another Japan, or another Germany, and this within a few years, a decade or two at most. Only to be sorely disappointed - again, and yet again.

It's not just about the economics, stupid. It's about economics, property rights, spare capacity, a decade or two of better-than-average leadership, enough accessible justice to thwart open protest and vendettas, the right incentives, and that the commoners have hope.

History repeats itself, true, in rough outlines, but not every country that is emerging actually does so, in the same way that not every egg gives us a chicken. Some give us eagles, others delicious breakfasts, some eggs just rot, and some actually turn into snakes.


But I guess the phenomenon "BRIC" captures goes beyond simply countries emerging into economic powerhouses. It's about a seismic economic development which the world has never seen before: the economic awakening of four huge countries comprising a little less than half the world's population and one-fourth of its land area.

In a way, BRIC is a coincidence of timing. Other than that, though, investment-wise, the B-R-I-C countries cannot be more diverse. Does it make sense to invest in, say, one ETF to capture all the four countries? Not really. Does it make sense to have one ETF investing in the four? Definitely, if you are an ETF provider, because it sells. A solid word which rolls off the lips, gargantuan concept, investors want it.

How about that other recent acronym, PIGS? I find it rather insipid. More show than content. But it reminds us that world history is full of weird turns and the era of BRICs is being accompanied by huge jolts to the big economies of Europe and the US.


This is the most recent of the new terms, two words split and then spliced, like "nexit", for "next exit" .

It is supposed to capture the possible exit of Greece from the EU but it also being used to capture the process of European disintegration and the ramifications of countries' exit on the rest of the world.

It always pays to think ahead but rarely, to continue the analogy, to count the chickens before they hatch.

Europeans in the EU are extremely reluctant to let Greece go. Imagine the USA without Massachusetts, or Canada without Kingston or Halifax. If it is ejection versus some roundabout way of printing money, which do you think will win the day? Especially if the more fiscally responsible countries are persuaded that the new money will be sterilized out of circulation so it won't cause inflation?

Strategically, too, will the EU withdraw from the East Mediterranean and what would happen if Turkey was eventually admitted to membership? There are a host of considerations down this lane, if only because Greece, Turkey and Cyprus, another EU member, are so close to the Middle East.


Anything might happen, and there is a chance that the situation might get out of hand, with more funds withdrawn and public unrest, but if Greece goes, the pressure on Portugal, Spain and Italy, probably at the same time, would be inexorable. Better expand the list of assets which the European Central Bank, and countries' central banks, will accept as collateral as quid pro quo for low interest loans.

Better yet, issue bonds underwritten by the EU and give the ECB powers to lend directly to individual banks. But, as Germany argues, banking health should be the responsibility of individual countries and it is unfair to issue bonds in common if spending is not.

The German position seeking discipline and austerity is perfectly understandable, and the right thing to do. I wonder where the Euro and debt levels would be today if someone had not stood up for prudent fiscal and monetary policies.


We all know where lack of prudence got us: savers in the West are now subsidizing the mountains of ills brought about by lax banking regulation, one-way bank incentive programs, government munificence and tax evaders, by being forced to accept near-zero interest rates for hard earned savings, and thus forced to take on what's often inappropriate risk.

But will the conservative prudent core keep insisting on austerity and cuts if it means a shrinkage of territory and possible financial chaos? I very much doubt it.

Politics is first about territory, and only second about economics. If there's territory, economics will follow. But will territory persuade the Germans? It is likely to; the initially bad economics of integrating East Germany with West Germany on an equal basis (one deutschemark for each ostmark) did not stand in the way of German Reunification. (No, it's not because each Greek Member of Parliament immediately gets a private Mercedes Benz!)

And keep in mind another thing: a few years back, the major debate in Europe was about the appropriate balance between federalism and sovereignty of the separate states. The German-French axis at the centre of Europe is more than just about fiscal and monetary prudence.

Having the federal structure that we now have, we seem to think that Canada and the USA became federal states immediately and without struggle. But this is mistaken. Turning independent areas or states into a federal structure is a long-term, often hidden agenda, which gains the upper hand when the weaker states come to need the stronger. So, the present financial crisis in Europe may be a blessing in disguise.


It has long been apparent, and many had written about it at the time, myself included, that monetary union necessitated a common treasury. This is not something Europe discovered now, because of Grexit. But in investments and economics we always have to ask, "then what?".

The "then what?" is that a common treasury can only be effective if the authority administering it has executive powers against the states. And this, at the time, threatened to derail the planned economic and monetary union and the powers that be decided - I think wisely - to carry on regardless. No country was going to trade its sovereignty for a potential problem in the future, albeit they did agree to various sanctions if fiscal targets were not met.

The future in Europe is not likely to be very different from that in the US: huge public debt, low interest rates, more regulation, the inability to rein in banks, and walking the tightrope between deflation and inflation in order to keep things going without too many fatalities until, somehow, someday, growth eventually sprouts. Long and messy winters of discontent, although I am more optimistic about the US economy since there are various signs of improvement.


A prolonged EU slowdown is likely to hurt North America, but not fatally. Canada imports around 8% of merchandise and services from the EU and our exports to the EU are around 13% of the total. The US imports around 18% of its total imports from the EU and exports 21% of total exports. Canada is less open to the EU, which is probably the main reason for CEFTA, the proposed Canada-EU Free Trade Agreement.

One would also have to consider indirect effects, however, such as increased protectionism, a reduction in the demand for resources sold to the EU indirectly via the US, China and other countries, and reduced revenues for North American companies operating in the EU, all of which may prove to be substantial. All of this adds to dampen the already fragile recovery in the US.

Ironically, the troubles in Europe may make this a good time to invest because, as we see, it is taming stock markets around the world and the time to invest is when prices are depressed.

To conclude, there is always the possibility that the EU system will break down, that Greece and others will be ejected, namely, a scenario of Grexit, Porxit, Spexit, and Itexit, but envisioning something is not the same as making it happen and, remember, shorting and other kinds of pressure can be rendered illegal overnight.

Tune in for good prices. Especially for those with a buy list of European stocks.

This article is not intended to be relied on as specific investment advice, nor as a solicitation to invest or trade any securities mentioned. We recommend readers to seek advice from an investment, tax, legal or other professional adviser. The information herein is based on sources we consider reliable but we are not liable for their accuracy. Opinions expressed here may change without notice.

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