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Greece’s Bailout Deal Explained with a Euro-Parable

The following parable pretty much explains the bailout deal reached late Sunday night. This actually made the online rounds back in December 2011, but it still applies today and isn't that much of an exaggeration. Enjoy!

It’s a slow day in a little Greek Village. The rain is beating down and the streets are deserted. Times are tough. Everybody is in debt. Everybody lives on credit. On this particular day a rich German tourist is driving through the village. He stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night.

The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher.

The butcher takes the €100 note and runs down the street to repay his debt to the pig farmer.

The pig farmer takes the €100 note and heads off to pay his bill at the supplier of feed and fuel.

The guy at the Farmers’ Co-op takes the €100 note and runs to pay his drinks bill at the local tavern.

The tavern owner slips the money along to the local bookie drinking at the bar, who has also been facing hard times and has had to offer him bets on the horses using.

The bookie then rushes to the hotel and pays off his room bill to the hotel owner (he drank too much one evening and couldn’t drive home) with the €100 note.

The hotel proprietor then places the €100 note back on the counter so the rich traveller will not suspect anything.

At that moment the traveller comes down the stairs, picks up the €100 note, states that the rooms are not satisfactory, pockets the money, and leaves town. No one produced anything. No one earned anything. However, the whole village is now out of debt and looking to the future with a lot more optimism.

And that, dear readers, is how the bailout package will work!

Yes, we finally have a deal in Greece, but by many accounts it is not materially different from the deal(s) Greece rejected over the past few weeks. The fallout from the Greek street has been swift. Now Prime Minister Tsipras has to get to work convincing the Greek people that as difficult and long as the path ahead may be, it’s the only way out.

If you would like to read the Euro Summit statement, you can find it here. Its main points include:

 A "significantly scaled up privatization program with improved governance."

 "Ambitious pension reforms" and measures to make the system more affordable.

 General deregulation and liberalization of Greece's market economy, with areas such as pharmacies being opened up to more competition.

 A "rigorous review" of modernizing the Greek labor market.

 Depoliticizing the Greek governing establishment — it's a common criticism that Greece's government is riddled with cronies from whichever administration is in office at the time.

 Amending or rolling back some legislation that has been passed in Syriza's first six months in power, much of which ran against previous bailout deals.

Margin Call

Currencies were under a lot of pressure for the first three days of last week as safe haven flows into the yen and USD dominated due the continued uncertainty in Greece and China. By Thursday, safe haven flows subsided and gradually reversed as the slew of Chinese government measures utilized to stop the equity markets from falling finally took hold. For now, this helped to stabilize the market and allowed currencies to rebound against the yen and USD. Stability continued to take hold on Friday as a sense of optimism over a potential Greek deal emerged. Thus, the only two currencies that moved by more or less than 0.50% for the week were the AUD and CAD.

It’s not surprising to us that the two outliers for the week were the AUD and CAD because it’s become apparent that the turmoil in the Chinese equity markets, and the slower economic growth in China in general, have weighed heavily on commodity prices. The fall in energy (oil for Canada) and industrial commodities (iron ore and copper for Australia) show no sign of abating as of yet and will continue to cast a long shadow on the respective currencies.


New Zealand may be spared the brunt of the fallout as agricultural commodities are more insulated from economic downturns in general since people still need to eat. Having said this, the fall in the two currencies last week was all about monetary policy. In Australia, on Tuesday keeping interest rates on hold at 2% for the second-straight month. However, the Aussie fell anyway after Reserve Bank governor Glenn Stevens said "further depreciation (in the currency) seems both likely and necessary, particularly given the significant declines in key commodity prices”.

Meanwhile in Canada, the key driver in CAD weakness was the cumulative soft economic data on top of the prior week’s negative GDP growth for April. Speculation has risen that the Bank of Canada will deliver a rate cut at tomorrow's policy meeting. Frankly, we would be surprised if they choose to wait until their September meeting given the string of disappointing data and the characterization of its surprise January rate cut by Bank of Canada governor Stephen Poloz as an “insurance policy”.

As we pen this blog, we feel a sense of exhaustion over thinking about the deal between Greece and the Eurozone. After the last couple of weeks we think that everyone, including ourselves, is suffering from crisis fatigue – not just about Greece but the 30% drop in the Shanghai Composite index over the last 3 weeks and 20% drop in oil, just to name a few. All of this is resurrecting fears of deflation or disinflation again, which may kick off a new monetary easing race by central bank; like it did in January of this year. Therefore, central banks look to ease policy further or to leave rates lower for longer.

Whatever happens in Greece is critical for the week ahead in markets, but what transpires in China will matter for many more months. Why? Because it renews fears of downside risks to global growth. We mentioned last week that China’s array of policy measures to arrest the fall in their stock market reeked of desperation. Unfortunately, last week they had to deploy even more measures before the stock market was able to stabilize. This stability will only last a short while because the reason behind the plunge in stock is margin calls. Investment bank, Goldman Sachs, notes that China’s margin debt is the highest in history of global equity market and stands at 12% of the free float market cap of imaginable stocks. So when equity prices began to fall about 4 weeks ago, it set off a wave of forced selling of shares due to margin calls. And with more than 90 million "retail" investors involved in the stock market, more downside is expected due to forced selling created by margin calls. The fear for all of us is that the stock market crash will dent Chinese consumer sentiment and derail whatever economic momentum China has left, which in turn could spread and derail the global economy.