Saturday, February 27, 2010

>GREED & FEAR: No reprieve (CLSA)

One week on and “oversold” markets want to celebrate the fact that Greece has been given a one month reprieve to get its fiscal house in order. While it is natural that investors would like to forget about the problem, in GREED & fear’s view it is clear that the real crisis over Greece and the rest of the PIIGS lies in the future not the past.

The past week has made it clear that German public opinion, and therefore the German political process, will not tolerate a crude bailout of Greece; even if it is via “subtle” off balance sheet guarantees and the like. For example, why should Germans agree to a bailout of Greece with its statutory pension age of 61 when Germans do not receive pensions until the age of 67? Meanwhile, the level of fiscal austerity being demanded of Greece, namely a decline in the projected fiscal deficit from 12.7% of GDP in 2009 to 2.8% of GDP in 2012, is in GREED & fear’s view wholly incompatible with the reality of Greek democracy. In this respect the charge by the Greek Prime Minister George Papandreou over the weekend that the country was being treated as a “laboratory animal” by the European Commission is a reflection of the prevailing “Club Med” mentality.

The reality is that this drama will come to a head sooner or later. And with Greece needing to raise €20bn in the next three months it could be sooner, especially as some other “Club Med” countries also face significant debt refunding schedules between March and May. Thus, Spain and Portugal have €31bn and €11bn of government debt maturing in the next three months.

Macro traders should therefore keep on the long recommended PIIGS spread trade (see Figure 1). Investors should also assume that there will be further negative pressures on the euro, which implies continuing strength in the US dollar. In this respect Otmar Issing, a former member of the European Central Bank’s executive board, is quite right to argue, as he did in an article in the Financial Times on Tuesday (“A Greek bail-out would be a disaster for Europe”, 16 February 2010), that a bailout of Greece would undermine the foundations of European monetary union and, therefore, the credibility of the euro.

All this means that the future of the euro as a hard or soft currency will be determined, as noted here last week, by whether Europe’s politicians opt for the hard or soft option (see GREED & fear – Hard or soft in Europe, 11 February 2010). But until Europe passes this stress test the market is likely to assume bailouts and the like, so accustomed have investors become to the moral hazard generated by government guarantees in the Greenspan and Bernanke eras.

But what investors need to remember is that this is a crisis not centred on Washington. GREED & fear remains sceptical whether Germany will really opt for a bailout, or even a “fudge” option. And if it does not the deflationary consequences will come as a real shock to markets. Meanwhile, it goes without saying that the fundamental flaw in Euroland is the incompatibility of having monetary union without political union. This was always understood by the eurosceptics in Britain, like the great Margaret Thatcher, though naturally the Euro-enthusiasts will try and spin the latest crisis to argue for the need for political union. They are unlikely to

Meanwhile, with European issues dominating the headlines, focus has switched away from Asia for the moment. Still GREED & fear remains convinced that sell-offs caused by Greece and the like represent great buying opportunities in Asia since this further assures a continuing environment of very low interest rates in the West which can only generate excess liquidity bound for Asia. Who, for example, is talking about exit strategies in Europe right now?

To read the full report: GREED & FEAR