The Greek election could be a major inflection point for Europe’s future

Because I’ve been predicting GFC 2.0 for the past 2 years, I have limited myself from investing in public markets for this period, except for a couple of stocks like BGL and CKL, as well as a position in several gold shares as a defensive play which sit outside the value methodologies (so I haven’t written about them here).  Almost since the last GFC, central banks around the world have tried to lift global economies into a sustained recovery by continuous stimulation of the economy, while at the same time participating in a currency devaluation warfare in which the USD, Euro and Yen all take turns vying to see who can print the most money, devaluing their currency and stimulating exports.

Seeing as these 3 regions account for about 52% of GDP according to IMF’s 2013 numbers, most of the rest of the world is along for the ride.  Unfortunately, all 3 regions have a terminal addiction to cheap debt (their only option is to balance budgets triggering a depression, or default/hyperinflate their currency).  I’m excluding China from this group (12.5%) because the Yuan is not a reserve currency.

Over the past couple of months we’ve seen some dramatic changes in commodity prices and economic policy:

 

  • Iron Ore is now under $70 a tonne, meaning every producer in the world (except 3) is now operating at a loss
  • Oil is now under $50 a barrel, driving oil-rich OPEC welfare states to drill even more in an effort to balance their budgets
  • Copper, usually a leading indicator of economic health, has fallen to around $2.50 a lb
  • The Swiss National Bank suddenly removed their 1.20 Euro currency floor after intervening for 3 years to keep their price low.  Within an hour the Swiss Franc revalued itself 30% higher, not before obliterating every leveraged Forex trader who was short CHF
  • Denmark and Switzerland have both implemented negative central bank interest rates
  • Venezuela and Argentina have both implemented price and capital controls, resulting in rioting and major shortages of basic household essentials

 

The only thing more staggering than current government intervention, is the amount of debt these government owes to bondholders, as well as their own reserve banks, who are buying up their own government debt with newly created money.  The Eurozone looks to be the first to fall, and I suspect the catalyst will the election of Syriza in this weekend’s Greek election.  Negotiations with the ECB will fail, or Greece will fail to keep their side of any deal which does get negotiated, resulting in more standoffs or an exit of Greece from the Euro.

 

The problem with balancing a budget when you have a gigantic debt millstone around your neck, is that you cannot escape.  If you raise taxes, the wealthy will leave or be bled dry, curtailing private investment and further growth.  If you cut spending, the GDP will fall, triggering a depression, which will incite riots and the election of political nutjobs.  If you default, your problems are gone, but you carry the reputation of a deadbeat nation who will not pay their debts.  Or you can keep printing money, which will eventually hyperinflate your currency like in Germany in the 1920s, which is technically the same as default, because the money you repay your bondholders is worth less.

 

Greece is a $250B economy, and they actually ran a primary surplus in 2014 (They balanced the budget excluding debt repayments).  Italy’s economy is $2 Trillion, and Spain is $1.3 Trillion.  If Greece’s problems are creating this much anguish in the Eurozone, what’s going to happen when Italy (2.8% deficit) and Spain (6.8% deficit) queue up for handouts?  Combined, their economies are the same size as Germany ($3.6 Trillion).  I see no way that Greece can run a budget surplus in 2014, even if all government debts are cancelled.  Tax collections fell dramatically in the lead-up to the election, and Tsipras has made some very costly election commitments.  Moving back to the Drachma will be purely driven by how accommodating the ECB are to maintaining the status quo, but if the bailouts continue, Italy and Spain’s demands will eventually overwhelm the ECB’s ability to keep things going.  A harsh economic readjustment for southern Europe is inevitable long-term.

 

Even though the USA has problems, the almighty dollar is still going to be a safe haven.  John T Reed, an American, has written an excellent article on why the USA will fare reasonably well in the next economic downturn:

In 87% of the transactions, the USD is on one side. In only 13% are neither side either buying or selling USD. In other words, no one who needs a substantial amount of USD or USD bonds can switch to another currency. There is no such currency and none is on the horizon.

The article is interesting throughout and I highly recommend it.

I expect major problems in the Eurozone which will trigger major disruptions to markets, commodities, and currencies. The likely outcome is a stock market collapse and increased demand for precious metals.  Japan’s future is not a matter of if, but when.  Most of my money is in cash right now as I am anticipating Australian equities will get cheaper.