Ben Strubel: Special Report On Greece’s “Crisis” by Strubel Investment Management
If actor Rob Lowe is weighing in on the Greece situation on twitter I guess I better too.
Here we are again for the third or fourth time in five years and nothing has really changed.
“I’ll tip my hat to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around
Pick up my guitar and play
Just like yesterday”
-The Who, Won’t Get Fooled Again
Below is our 13F roundup for some high profile hedge funds for the three months to the end of March 2021 (Q1). Q1 2021 hedge fund letters, conferences and more The statements only include equity positions as 13Fs do not include cash and debt holdings. They also only include US equity holdings. Funds may hold Read More
So without further adieu, let’s get started.
P.S. If you don’t want to read the whole thing here’s the executive summary: The Greek economy is just too small to matter. Once the situation is resolved one way or the other the market will return to normal since the world economy is actually growing!
Unfortunately, I’ve found the US media has done a pretty appalling job covering the story. I’ve generally found British, Irish, and when English versions are available French, German, and Greek news outlets to provide much better coverage of events, although the Greek and German sources are quite biased.
Before I begin let me clear one thing up. What’s happening in Greece can never happen here because, thankfully, we control the currency or debt is issued in. Unfortunately for Greece they use a foreign currency, the Euro, which they do not control (the European Central Bank, not the Greek Central Bank, controls it).
First, some background on the crisis. In 2010 the ECB (European Central Bank), IMF (International Monetary Fund), and EC (European Commission) provided a €110B bailout to Greece. As a condition of the bailout they required Greece to implement a number of austerity measures. This caused a long, deep recession and necessitated yet another bailout. As a condition of the new bailout they were once again required to implement austerity (spending cuts and tax increases). Predictably the recession worsened. There were two more bailout extensions and increases in loans.
Because the creditors forced the Greek government to cut spending and raise taxes Greece has been mired in a depression. Unemployment is over 25%, youth unemployment is over 50% and the economy as a whole has shrunk almost 30%! The Greek depression is now worse than the US Great Depression. In the graph below by Professor Bill Mitchell you can see that it has been just as deep, but extended much longer than the Great Depression.
The Greek depression has also made their debt burden even worse. As the Greek economy shrunk the debt burden became an ever larger portion of the economy. For example if Greece GDP was €100B and the owed €50B the debt to GDP ratio would be 50%. Now if GDP shrunk to €70B and the debt stayed at €50B the debt to debt would be 71%. As the Greek economy shrinks the debt burden becomes ever more unbearable. It’s about 180% or so of GDP now.
Next let’s go over who the major players are.
We have what is essentially four way negotiations between four different groups of people each with slightly different agendas.
1. The Greeks, obviously.
2. The Political Idiots – These are mainly the prime ministers and finance ministers of the various Eurozone countries. They are primarily concerned with maintaining power and currying political favor at home. They seem to want to see Greece’s defiance of them punished and don’t particularly care about the situation in Greece. For them, seeing Greece leave the Eurozone and EU isn’t a big deal.
3. The Technocrats – The EC and the ECB. The Euro and the Eurozone is their baby and their main concern is maintaining stability and increasing their own power. They definitely don’t want Greece to leave since that would be seen as a large failure on their part and also diminish their power. The less countries in the Eurozone, the less important the Eurozone is and by extension the less important they are. For what it’s worth the ECB seems much more willing to see a deal get done than the EC.
4. The IMF – At this point Tom Cruise a/k/a Ethan Hunt of the Impossible Missions Force could probably do a better job. Greece has defaulted to these people. Managing director, Christine Lagarde, definitely does not want to be the one on watch when Greece becomes the first country ever to not pay back the IMF. They would probably be up for any deal as long as they get paid back. It’s also worth noting that the research arm of the IMF promotes vastly different and much better policies than the political arm.
5. The Troika – The combination of the ECB, EC, and IMF.
It’s also important to note that people flit back and forth between groups 2-4 based on their past history or future career goals. So, not all views in each group are homogenous among all members.
Now let’s address a few myths about the situation.
1. The Greek People and Government Got Bailed Out
The first thing we need to understand is that Greece really didn’t receive a bailout. The German, French, and Greek banks received a bailout. Of the €252B that Greece has received €232.9B or 92% has gone to pay bondholders, banks, and to pay back the very institutions that lent the money (a farce of epic proportions, loaning new money to pay back old money). The real amount of money the Greek people and government received is more along the lines of €20B
This is one of the big reasons for the friction between the Greek people and the creditors. The creditors are essentially demanding that ordinary Greek citizens pay back the banks. It’s not like the Greek people bought a brand new Mercedes and then defaulted on their car loan and are now throwing a temper tantrum when the bank wants their money back. Think of it as your home town bank made a bad loan or two and now all of a sudden the branch manager shows up at your house and demands 40% of the money in your IRA retirement account.
2. Greeks Are A Bunch of Lazy Early Retirees
You often read how Greece has a very generous pension system and how many Greeks, especially public sector employees, can retire early. The average retirement age in Greece is somewhere around 59 or so I believe. This one is true so far as people in Greece retire earlier than elsewhere.
However, it is worth noting the average Greek works 2037 hours per year while the average German works only 1388. So if someone from Greece gets a job at 24 and retires at 59 they will have worked 35 years or 71,295 hours. That would mean a German getting would need to work until 75 (if hired at 24) to work the same number of hours. (FYI, as of a few years ago the average German retires around 62).
Also, Greece spends a smaller portion of its GDP on social welfare than Germany and many other countries in the Eurozone. In 2013 Greece spent about 22% of GDP on social welfare while Germany spent 26%. France led the way with 33%.
What most people don’t understand is that Greece is not like countries such as Germany or France that have better developed social welfare systems with comprehensive unemployment insurance schemes, housing vouchers, food assistance, and other government programs to help the less well off. Instead, Greece relies on pension payments as sort of a catch-all welfare solution. A retired grandma and grandpa collecting a pension may be supporting several unemployed relatives with their pension checks.
The lack of understanding of the role of the Greek pension system in everyday life has led to the a large portion of the populations in Germany and other Eurozone countries as seeing the Greek pensions as essentially their tax money (via the bailouts) allowing Greeks to retire at 61 and thus want them cut. The Greeks on the other hand see the pension system as essential to fighting mass poverty and refuse to cut them any further (they’ve already been slashed 40%).
Unfortunately rather than attempt to educate their populace or propose pension cuts combined with other types of social support payments the creditors seem concerned mostly with maintaining popular support in their home countries.
3. It’s the Greeks Fault They Got in This Mess
It’s only the Greeks fault so much as you blame them for joining the Euro in the first place. The problem for Greece is that the Greek economy is vastly different than Germany’s or really any other European economy.
In the United States we have 50 different states that all us the dollar despite having big economic differences. Alabama and Mississippi are not even in the same economic world as California and New York. But, the arrangement works for two reasons. First, there is labor mobility. It’s easy to move from one region to another. Europe does not enjoy the same labor mobility. You can’t move just from Greece to Germany. By contrast a move from Arkansas to Texas is just a phone call to U-Haul and a six pack of beer for your friends that you con into helping away.
But, most importantly we have a fiscal union. That is the federal government provides vast amounts of financial assistance to states. Better off states such as the aforementioned NY and CA see some of their dollars transferred to economically weaker areas of the countries. Highway funds, education funding, social welfare funding, and on and on are all done through the federal government.
The Eurozone has no fiscal union. There is no way for money to be transferred from stronger economies like Germany to weaker economies like Greece, which is a necessity if both wish to use the same currency. If they didn’t use the same currency, the Greek drachma would simply be much weaker than the German mark, thus equalizing the two economies. But because they are both yoked to the same currency the economies are unable to be balanced.
What Might Happen
Let’s get the first thing out of the way. There is no way Greece can ever pay back all of the money that was loaned. It’s simply too much debt for such a small economy. Additionally, making the Greek people suffer for bad lending decisions by the banks is simply unconscionable. Any solution that doesn’t involve writing down the debt is only a short term fix and will mean we will have another mini Greek drama pop up for the fifth time.
Scenario 1: Greece Votes Yes to the Referendum
Current polls suggest that this is the most likely decision. If this is the case the current prime minister has indicated he will resign (or maybe he won’t, at this point who knows). This will lead to new elections and the installation of a government willing to agree to the Troika’s condition. The market will rejoice with this result since it means the threat of a “Grexit” is off the table. Unfortunately for the Greek people it means more suffering and agony as further austerity is imposed.
Scenario 2: Greece Votes No to the Referendum, Europe Brings the Hammer Down
If the Greeks vote no, the ECB has an ace up its sleeve to force a deal on whatever terms they desire. They will use the same strategy they used on Cyprus. Greece’s banking system is essentially insolvent and the ECB has been looking the other way and just pretending it wasn’t. Under this scenario the ECB would stop pretending the banks were solvent and simply recognize them as insolvent and declare they must be resolved. I’ll skip the gory details of how the banking system functions and skip to the important part; the Greek depositors would lose pretty much all of their deposits, perhaps getting only a few cents on the dollar. This threat of a bank “bail in” was used to get Cyprus to agree to a deal (and depositors actually did lose money as well). This threat would likely force a new Greek government (I’m sure Tsipras would resign) to swiftly agree to the deal. The markets would then rejoice because the threat of anything bucking the system is removed.
Scenario 3: Greece Votes No to the Referendum, Back to the Bargaining Table
If the Greeks vote no and the ECB stays out of it and does not use their nuclear option of a bank “bail in” it’s back to the bargaining table. This time July 20th seems to be the real drop dead line as Greece has a payment due to the ECB. If Greece does not make the payment then their banks are not eligible for support and the ECB is forced to resolve them. So, we will likely see a good bit of market turmoil until the 20th as the Greeks and the Germans call each other names and attend endless summits. If a deal is reached, and really any deal would suffice the markets would rejoice as the situation is resolved. If no deal is reached Tsipras will likely resign, a new government will be formed, and the ECB will impose whatever terms they want. The market will then rejoice.
Scenario 4: Greece Votes No to the Referendum, Leaves the Euro
This is the dark horse scenario. It’s highly unlikely Greece will leave because the mechanics of doing so are complicated. What an actual “Grexit” might look like is the introduction of IOU’s or some type of parallel pseudo currency that is gradually phased in over time. In this scenario the market will turn their focus to the speculating on the possibility of other weaker members like Italy or Spain leaving. It will likely take some sort of action from the ECB to calm things down. Greece, if it left, would likely enter a very sharp recession but if the economy is managed correctly will quickly resume growth. In this scenario we would likely have several more months of market turmoil before things returned to normal.
In late breaking news a fifth scenario has popped up. There may be some sort of deal before the referendum. I would imagine this deal would mean Tsipras largely ceding to creditor demands. The renewed austerity will cause another downturn and I’d imagine the Tsipras government wouldn’t be around for long. Again, the markets would rejoice.
What the Heck Does All This Mean For Me?
The short answer is nothing. The Greek economy is only about .4% of the world economy. Greece’s economy is about as large as Oregon or Louisiana. It’s not a significant exporter or a large import market at this point. Greece could disappear tomorrow and the world economy wouldn’t be troubled (sorry Greece, and by extension Oregon and Louisiana).
What people are worried about isn’t Greece; it’s that a Greece exit from the Eurozone may lead to a domino effect whereby other weaker countries like Spain, Italy, and even France run into trouble. This is unlikely to happen as the ECB has stepped in and said it will do whatever it takes to keep those countries borrowing costs reasonable. So, at least in the short term, a Grexit, will not have any spillover effects. Greece’s economy is so small that it just simply won’t affect the rest of the world no matter which scenario plays out.
All we have to do is weather the storm until some sanity returns to the market.
What are your thoughts on the crisis? If you have any questions or comments feel free to send me an email or give me a call.
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