David R. Kotok
Cumberland May 3, 2015
The way we see it, history is needed to guide us. Greece cannot continue indefinitely in depression, and it cannot pay. There is no good outcome. The people of Greece need a political outcome to give them a victory.
We will invoke two historical images, one at the beginning of this commentary and one at the end. The first comes from research work by Harvard’s Thomas Bulfinch (1796-1867). He is the iconic expert on mythology. He wrote:
[I]t will be necessary to acquaint ourselves with the ideas and the structure of the universe which prevailed among the Greeks – the people from whom the Romans, and other nations through them, received their science and religion.
The Greeks believed the earth to be flat and circular, their own country occupying the middle of it, the central point being either Mount Olympus, the abode of the gods, or Delphi, so famous for its oracle.
The circular disk of the earth crossed from west to east and divided into two equal parts by the Sea, as they called the Mediterranean, and its continuation the Euxine, the only seas with which they were acquainted.
Around the earth flowed the River Ocean, its course being from south to north on the western side of the earth, and in a contrary direction on the eastern side. It flowed in a steady, equable current, unvexed by storm or tempest. The sea, and all the rivers on earth, received their waters from it.
The northern portion of the earth was supposed to be inhabited by a happy race named Hyperboreans, dwelling in everlasting bliss and spring beyond the lofty mountains whole caverns were supposed to send forth the piercing blasts of the north wind, which chilled the people of Hellas (Greece). Their country was inaccessible by land or sea. They lived exempt from disease or old age, from toils and warfare.
Let’s move to today.
Greece remains the main focus of attention and officials seem to be inching closer toward a deal, as the Greek government is running out of cash. However, the risk of Greek default is rising. A EUR 201 mln interest payment to the IMF is due Wednesday.
– Action Economics, global edition of Action Weekly, May 4, 2015
Five years after the initial bailout of Greece, the Athens government again is teetering on bankruptcy. The gap remains wide between the EU-led by Germany and demanding further reforms in exchange for the credit Greek needs to stay afloat – and the Greek government that is overseeing an economy suffering from a deep depression. Devaluation traditionally has been the palliative for such economic pain. Remaining in the common currency removes that possibility.
– Randall Forsyth, Barron’s, May 4, 2015, p. 5
For the last few days we have been engaged in economic exchanges about Greece with friends and colleagues around the world. We have been discussing all sides of the Greek debt/economics/governance problem. The opinions about the probable outcomes are diverse. The predictions and recommendations range from default, Grexit, and devaluation (my ultimate forecast, although when is uncertain) to further extension of credit (the can-kicking solution to the present crisis), to contagion avoidance and eventual Greek economic recovery (how long that might take is uncertain).
And there are mixed versions of these outcomes as well as two currency proposals (euro external and drachma internal), Russia as Greece’s benefactor, and all sorts of other scenarios. Funding by the IMF and other institutions of enough money to repay the loans owed to those same institutions would amount to a minimalist, recycling approach. It would net no new money for the Greeks, and for the existing lenders it would be a rollover at the same excessive risk level. In the interim, the runs on Greek banks and nearby banks in six other countries continue. The Greek banking system is avoiding failure only by obtaining Emergency Liquidity Assistance (ELA) with the grudging approval of the European Central Bank. Watch what happens with the banks if a single institution faces an exhaustion of cash. We will see the Greek version of the British Northern Rock bank run. Risk of this type of accident is rising every day.
A good friend and policy maker wrote the following. We shall preserve anonymity.
As someone who has served in the capacity of economist within a political environment, I can say that my victories were to avoid the worst possible outcome. I apply the same criteria here. Grexit is not the better economic outcome when considered all in. And it is not the political choice. So, what needs to happen to get us to avoid the worst possible combined outcome, especially within the political constraints? The problem is that there are two political constraints – Euro group and Greece. There is a menu of reforms (we know what they are) that meet the conditions to satisfy both political sides. The grandstanding on Greece’s side isn’t in their domestic economic or political interest…. At least not of Tsipris although perhaps that of Varoufakis…. Hence the new internal divisions within the Greece side. I remain hopeful of sanity.
We invoke a quote from Albert Einstein: “We cannot solve our problems with the same thinking we used when we created them.” Einstein also defined insanity as doing the same thing over and over and expecting a different outcome.
The retired chief strategist of a major global firm disagrees. He wrote:
It seems to me that being unwilling to bite the bullet ensures its ultimate travel to the heart. History reveals many examples of this lesson. In this case, the biting should have come quite a while ago, but better late than never.
A detractor (me) wrote:
Greece came into the euro with faulty data and then revised after entry. And there was no way to deal with a prevaricating new member. So the euro system powers at the time bit the bullet. Then Greek debt was downgraded. Again the euro system leaders allowed rule changes. Then Greece defaulted. Euro system leaders extracted penalties and extended more financing. Now the game is played again. I also would note that when Greece did restate and revise its GDP in order to comply with the required level, it did so by raising the services portion. When you dig into that detail, the highest upward revisions came in money laundering and prostitution. If the euro system leaders extend more credit, what do you think Greek behavior will be?
My comment brought some harsh criticism regarding the reference to adding to GDP by counting prostitution in the growth of the service sector. However, we do not factor that into GDP in the US. My good friend Bob Parker is an expert in statistics who honed his superb skills as the Chief Statistician of the United States. He sent me a note and a link and gave me permission to cite his “ongoing research on implementation of international standards for measuring GDP.”
Here is the link from Bob to an article that discusses how European statistical agencies deal with prostitution, drugs, and other underground economic measurements. Readers may enjoy this one.
A former chief European strategist, also retired, of a major global firm took the other side. He wrote:
No matter how aggravating Varoufakis & Co. may be; no matter how tenaciously investors resist a new haircut, the underlying challenge in a “Grexit” is that markets then turn their attention to the huge bubble in euro-denominated government debt. If the markets home in on the real éléphants in the trading room, Italy and France are the obvious targets since they have done almost nothing to cut public spending. (While Greece, Spain and Ireland have.) Such pressure on Italian and French government bonds would sharply increase market volatility and weaken the euro to such a dangerously undervalued level (meaning, in relation to the overvalued USD) that it would force the G7 to take Louvre Accord-type action to stabilize FX markets. I remind those euro sceptics who would welcome Grexit that the ECB estimates total euro-denominated debt issued by résidents to be in excess of EUR 14 trillion. See: https://www.ecb.europa.eu/stats/money/securities/debt/html/index.en.html . Remember too that up to seven years maturity of the euro-denominated government debt market is now priced at negative yields. Do you really think the ten-year bund yielding 29 bps or the OAT yielding 57 bps, are realistic investments? If you want serious turbulence in that giant euro debt market, then Grexit could trigger it. Brace yourselves for a financial crisis that could dwarf that of 2007-2009 at a time when the Fed and ECB are virtually out of ammunition and our elected political ideologues refuse to take appropriate fiscal action.
We will end this note with a quote from The Phaeacians: Fate of the Suitors. The work is a retelling of the story of Ulysses, long separated from his wife, Penelope, while she has delayed suitors who claim that Ulysses’ absence is permanent. Ulysses masquerades as a beggar and watches as twelve suitors fail a test that would have resulted in the victor’s claiming his queen as their prize.
… humbly suggesting that he should be permitted to try; for, said he, “beggar as I am, I was once a soldier, and there is still some strength in these old limbs of mine.” The suitors hooted with derision, and commanded to turn him out of the hall for his insolence. But Telemachus (Ulysses son but that was not known to the suitors) spoke up for him, and, merely to gratify the old man, bade him to try. Ulysses took the bow, and handled it with the hand of a master. With ease he adjusted the cord to its notch, then fitting an arrow to the bow he drew the string and sped the arrow unerring through the rings.
Without allowing them time to express their astonishment, he said, “Now for another mark!” and aimed direct at the most insolent one of the suitors. The arrow pierced through his throat and he fell dead. Telemachus, Eumaeus, and another faithful follower, well armed, now sprang to the side of Ulysses. The suitors, in amazement, looked round for arms, but found none; neither was there any way of escape, for Eumaeus had secured the door. Ulysses left them not long in uncertainty; he announced himself as the long-lost chief, whose house they had invaded, whose substance they had squandered, whose wife and son they had persecuted of ten long years; and told them he meant to have ample vengeance. All were slain, and Ulysses was left master of his palace and possessor of his kingdom and his wife.”
The newest Greek government knows its history. Greek people wish for a 21st century Ulysses. They feel the chill winds that come from beyond the mountains of the north, blowing in from the bureaucratic caverns of Frankfurt and Brussels.
The final chapters of Greece’s story are yet to be written.
David R. Kotok, Chairman and Chief Investment Officer