The Greek Tragedy Rolls On
11/08/2011 7:30 am EST
It seems that no matter what happens in Greece, it’s never enough…and if the markets detest one thing, it’s uncertainty, observes Axel Merk of Merk Insights.
This week starts with a new unity government in Greece and Greek Prime Minister George Papandreou stepping down.
The sad part is that Greece has not been able to eliminate its primary deficit (the deficit before interest payments), so that it could have the potential to bounce back upon a default. On the contrary, Greece may fall into chaos or anarchy.
The threat of such a scenario, in turn, may prompt European policy makers to instigate a Marshall Plan to rebuild Greece. While we can ponder about the Greek drama, it’s paramount to contemplate the consequences for the rest of Europe and the euro.
First, the good news: market pressures should accelerate reform. Specifically, we expect bank recapitalizations will both be accelerated and increased in scope—if you can’t save the sovereigns, at least make the banking system robust enough to absorb defaults. That’s better than any insurance scheme policymakers can come up with.
Expect dramatic actions by policymakers, akin to those seen in October 2008. Just as policymakers did not initially heed the markets then, the pressure is now on to follow through with substance after last week’s sketchy plan to save Europe, and ostensibly, the world.
Specifically, pressure on Italian Prime Minister Berlusconi is mounting rather dramatically to engage in real pension reform. In comparison to both Spain and Ireland, which have seen relative market improvements, the markets have scolded Italy. While it is possible to turn the tide, the longer the wait, the more the market will demand.
What would alleviate the pressure is a commitment by the European Central Bank (ECB) to be the lender of last resort for Italy and Spain. However, that’s unlikely to happen, at least not in the short term.
Any revised bailout fund for Italy is likely to cost France its AAA rating. France itself also has lots of homework to do.
The lesson here is that policymakers always wait until the last minute to engage in reform. Some day down the road, the market will focus on the US; at that stage, the US dollar may be under severe pressure: the US dollar is more vulnerable, given the significant current account deficit.
So for now, the drama continues. To summarize, expect more on bank recapitalization and reform. A wild card is whether the European Financial Stability Facility (EFSF) is going to be bolstered in earnest. For those politicians that still believe Greece can be held afloat: stop believing in fairy tales and move on. The market will.
As far as our positioning is concerned, we had increased our euro holdings ahead of the summit last week. We have since reduced it. We had also substantially reduced the yen ahead of that summit.
Our outlook calls for substantial volatility in all currencies, except for possibly the yen; as such, our risk assessment is currently favoring the yen disproportionally. As October 2008 has taught us, though, rational investors may be forgiven for changing their view of the world on a daily basis.