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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.

NSF - A Greek Tragedy

The correction in the USD index continues as Friday’s US nonfarm payroll showed that job growth collapsed to its worst level since December 2013. The US economy created only 126K jobs last month, which was significantly less than the 250K that was forecast. The report broke a streak of 12 straight 200,000-plus gains and employment gains for February and January were reduced by a combined 69K. The unemployment rate was unchanged at 5.5% while the labor-force participation rate fell to 62.7%, matching the lowest level in 37 years, as 96,000 Americans dropped out of the labor force in March. All in all, the disappointing report makes it more likely that the Federal Reserve will wait until the end of summer before raising interest rates for the first time since 2006. The news weighed heavily on the USD on Friday causing it to underperform against all the major currencies except one, the AUD.

Fundamentally, the USD will continue to be well supported by the dominate theme of the divergence of monetary policy between the Fed and the rest of the global central banks. The chart technical warns us that the USD has more room to correct in the short term. The daily chart of the US dollar index shows that the 5-day moving average remains below the 20-day moving average and that the momentum indicators have not found a bottom yet.

 

Over the next couple of weeks, Greece will dominate the headlines as it may not have enough cash to meet its debt obligations. Greece does not have the funds to repay €450m to the IMF on April 9 and also to cover payments for salaries and social security on April 14, unless the Eurozone agrees to disburse the next tranche of its interim bail-out deal in time. We assume that faced with a choice between a default to the IMF and a default to their people that the government will choose to not repay the IMF. If this happens it will be the first time a developed country has ever defaulted to the IMF. While the IMF will probably offer a short grace period before declaring Greece to be in technical default, Greece has other really big funding hurdles to face.

Greece also has Treasury bills totaling €2.4 billion that mature on April 14 and April 17. Most of this debt is sitting in Greek banks, which have been rolling over these bills with emergency funding obtained from the ECB, rather than demanding repayment from the Greek government. However, these two upcoming bills are different because at least €500 million is owed to investors outside Greece who are going to ask for their money back. This is where things could spin out of control – if Greece can’t pay, it would be a default. This would trigger clauses in Greece’s other debt obligations that would require immediate repayment of those debts as well. This has the potential to sends shockwaves around the globe, the ECB, and the remaining depositors in Greek banks.
Keep in mind that this would be similar to what happened in Cyprus as the ECB will force "bail-ins" on the depositors of Greek banks in order for the ECB to recover what is owed to them. We bring this up to demonstrate that Cyprus remains in the euro so it doesn’t necessarily mean that Greece will be kicked out of the Eurozone. However, Greece may choose to leave on its own accord or may be asked to leave by

the remaining members. Either way, the effects on the euro are uncertain to say the least. Initially, the knee jerk reaction will be to sell the euro but it could rise after the fact as markets deem the Eurozone to be stronger without its weakest link.

 



 

Allusion of Ever-Present Peril

Flippity-Flop

The highlight of last week was the release of the Fed minutes from the FOMC meeting on January 28th 2015

The FOMC statement from that meeting left a hawkish impression on the market, however, the minutes showed that Fed members were much more cautious, with many members saying they were inclined to stay at zero for longer. Members expressed concern that raising interest rates too soon could pour cold water on the U.S. economic recovery, and fretted over the impact of dropping "patient" from the central bank's rate guidance. Members also grappled with the weakness in international markets as well as worrying about falling inflation expectations in the U.S.

The flippity-flop in terms of the perception of the Fed’s first interest rate increase has had a hand in sidelining the USD as of late. The market will now look towards Fed Chair Janet Yellen’s testimony before Congress next week for insight into what the Fed is thinking. If Yellen comes across as hawkish then the market will expect a rate hike at the June meeting. However, if Yellen takes pains to explain the risks from a prolonged decline in inflation and the uncertainty in the international outlook then the uncertainty in the Fed’s first interest rate hike will continue to dog the USD.

Sword of Damocles

 

Finance ministers from the 19 countries comprising the Euro group has granted Greece a critical 4-month extension to its massive debt bailout so that officials can work out a longer term deal thereby prolonging the state of looming disaster for the shaky economic union. After trading many jabs and insults, it is safe to say that the easy parts of the negotiations are over. The deal won’t go into effect until the various national legislatures around Europe have approved it.

In some countries, particularly the Netherlands and Europe, this will be a tough sell. Understandably, some countries are frustrated at seeing their euros flow into a country whose economy never seems to improve.

The deal will mean that Greece will temporarily avoid going bankrupt as their financial lifeline is extended for 4 months. It should also mean that capital controls will not be needed and that Greek banks will have enough money to stock up their ATM’s. However, to get the money, the Greek government has one more hurdle to clear, which is to present a series of unspecified economic reforms measures that are deemed acceptable by creditors and rooted in Greece's previously enacted bailout agreement – something the government had promised not to do. Greece’s Prime Minister, Alexis Tsipras, now has to sell the Brussels deal and an eventual long-term agreement with the Eurozone not only to voters, but to Syriza's left wing and his junior coalition partner, the right-wing Independent Greeks.

These economic reforms should have been presented at the time of this writing. Notably, the Greek government will be the author of the reforms pursued, which has a rallying cry for the Syriza Party during Greek election campaigning. This represents a change from the past 5 years when Greece has relied on rescue money to avoid going bankrupt and was effectively ordered to enact a series of austerity measures by Berlin and Brussels.

Do You Hear Us, Berlin?

Do You Hear Us, Berlin?
 

By now, you’ve probably heard that Greece’s Syriza anti-austerity party won the election (probably 2 seats shy of absolute majority). Their new leader, Alexis Tsipras, campaigned on a platform to end austerity and renegotiate Greece’s debt repayments with the Troika, the EU, ECB and IMF. The ripple effect across Eurozone will be swift as the citizens of Spain and Portugal (and others) are keeping a close eye on how Greece will move forward after this rebellious statement. The victory had an immediate effect on the EUR as it hit 1.1098 in early morning trading – an 11-year low – but has since bounced back above the 1.1275 mark.

In his first act as Prime Minister, Mr. Tsipras visited the Kaisariani rifle range where Nazis executed 200 Greeks on May 1, 1944. This is hardly a subtle message to Greece’s paymasters in Berlin and Brussels. Ironically, the neo-Nazi Golden Dawn Party finished in third with 6% of the votes.

 

 

 

 

After five years of relentless belt-tightening, Greeks have said enough. It’s now up to the country’s euro-area peers to decide how to respond to the electoral landslide of the anti-austerity Syriza party.

The best-case scenario, according to Stathis Kalyvas, a professor of political science at Yale University, is that leader Alexis Tsipras “gets a few carrots,” signs off on a new bailout agreement under a new name, “and gets his party to approve it.” In this case, to which Kalyvas attaches a low probability, Tsipras will “reinvent himself as a social democrat, reform the Greek state, and dominate Greek politics the next 10-15 years.”

 

With 99.9% of the vote counted, Syriza, an acronym for Coalition of the Radical Left, took 36.3%, two seats short of an absolute majority. Tsipras will still get the mandate to form a government today, after securing the support of anti-bailout Independent Greeks party. Led by Panos Kammenos, Independent Greeks have vowed to negotiate a writedown on the country’s “odious debt.” READ MORE