Greece Interrupted — Bond Swap is Not the End

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Greece is set to swap its privately-held government bonds today for new ones that will represent a three-quarters loss of the original investment. The deal will allow the country to receive 130 billion euros in funds from its second bailout. Like the money from the first bailout, those funds will eventually run out however.   

The Greek bond swap is the biggest debt writedown in history. Over 85% of  private investors (essentially banks, the deal does not include bonds held by the IMF or ECB) holding 117 billion euros ($234 billion) agreed to the "voluntary" exchange. The CEO of one major European bank described the transaction as about as voluntary as a confession during the Spanish Inquisition. The loss to bondholders is twofold consisting of a reduction in face value of 53.5% and then lower interest payments stretched over a longer period of time. All in all, private bondholders are taking an approximately 74% hit (assuming of course there isn't another writedown or Greece doesn't renounce its debt completely in the future).

Credit rating agency Moody's decided to call a spade a spade and declared Greece to be in default. Moody's line of reasoning in stating the obvious is that it considers a loss greater than 70% to be a "distressed exchange" (that's putting it mildly) and is therefore indicative of a default.  The matter is not merely academic, since there is a significant amount of credit default swaps (bond insurance) outstanding on Greek debt. On Friday, a committee of the International Swaps and Derivatives Association —  the regulatory authority on credit default swaps — ruled that the Greek debt restructuring was a credit event, and this will trigger payouts. How much CDS holders will receive remains to be seen.

Commentary from the EU political leadership on the swap deal was more mixed than after the first Greek bailout (statements back then were upbeat and generally confident that the problem had been solved and Greece was on its way to recovery). French president Sarkozy stated, "Today the problem is solved. A page in the financial crisis is turning." Christine Lagarde, head of the IMF said, "The real risk of a crisis, of an acute crisis, has been, for the moment, removed." German officials were far more cautious however. The French may be correct as long as their words are taken literally. The problem is indeed solved for today. That doesn't mean it is solved for tomorrow.

It is actually highly unlikely that the situation in Greece will be turning around any time soon because of the massive reduction in its debt load from the bond swap. If Greece had a functioning economy, there would be hope. However Greece's economy is heavily dependent on government spending and in exchange for bailout money the IMF and ECB have demanded severe cuts in Greece's budget deficits. Greece is now entering its fifth year of recession, after GDP contracted by 7.5% in 2011. Investment fell by 21% last year after sliding 15% in 2010.  For Greece to continue to operate at all, continued bailout money will be needed. Greece has effectively gone from a welfare state to a state on welfare.

Not surprisingly, some analysts are sounding a note of caution. Predictions are that the financial bleeding in Greece will show up once again later this year. Problems may arise even sooner depending on when the next election takes place (now supposedly in May) and how much power the fringe parties gain. The bond market doesn't seem hopeful either. One year Greek government bond yields were last at 1143%.  Such yields represent collapse, not solvency.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Euro Problems Threaten World Markets

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


These days a trillion-dollar bailout just doesn't seem to go that far. Spending that amount to rescue the euro made the markets euphoric for only a couple of days. While stocks rose sharply immediately after the announcement, they are now selling off again. The euro itself is testing its low made in the fall of 2008.

The euro is being rattled today because of reports that French president Sarkozy threatened to pull France out of the currency union. This allegedly happened (the French deny that it did) at a May 7th meeting of ministers before the bailout plan had been worked out. If it did happen, it's old news. If you only read the press headlines though, you would think it had just occurred and is a new development. It didn't and it isn't. The source for this news item came from Socialist leaders in Spain. They may wish to see the euro system fall apart to further their own anti-capitalist agenda and to increase their personal power. So can you believe what they are saying?

So far in New York trade this morning, the euro (FXE) has traded as low as 123.24. This takes out the Credit Crisis low of 124.04 on October 27, 2008.  The euro has major technical support around the 125 area. A break of that level is a serious problem. The next step down is to around 120. A nose-diving euro is not just a problem for Europe however. In our globally interconnected economy, it will spread around the world like a financial tsunami. Not only is there a danger of dropping stock markets, but economies will be damaged as well. While the euro was falling this morning so were U.S. stocks. The Dow was down almost 200 points and the Nasdaq 60 points. The trade-weighted dollar (DXY) traded up as high as 86.24.

The euro has gotten to its current troubled state because of a complete lack of planning, an inability to face reality, failure to consider intelligent alternatives and a delay in taking action on the part of the eurozone leadership. Instead of making the hard decisions to handle the problems that began with the Greek debt crisis, they have engaged in stonewalling and dealing with the PR aspects of the problem, instead of solving the problem itself.  Unfortunately, this type of economic leadership is not unique to Europe, but is typical in most of the world today. If the euro blows up, Americans will be very much aware of it because of the big hole it leaves in the U.S. economy.

Disclosure: No euro or dollar postions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Toothless CFTC Tries to Bite Gold and Silver

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The U.S. CFTC (Commodity Futures Trading Commission) announced on January 14th that it was going to investigate trading in the gold and silver markets. This follows the commission's high profile hearings on speculation in the oil and natural gas markets held in the summer of 2009. Those led to the demise of the popular ETF, DXO and caused the natural gas ETF UNG to trade so irregularly that it no longer behaved like an ETF.  Both of these were investment vehicles for the small investor. Big-time speculators went on their merry way untouched and unscathed by the CFTC's action that was supposedly aimed at protecting the public. Anyone who was the least bit cynical might conclude that the CFTC's actual purpose was to protect the profits of the large commercial users of the commodities it regulates.

The CFTC efforts in investing oil and natural gas were in reality a thinly veiled attempt at price controls. Governments almost without exception resort to price controls when inflation becomes a threat. Price controls are of course extremely effective - not in controlling prices, but in creating shortages and driving prices much higher than they would have been if controls hadn't been implemented. Governments never learn however. In the short-term, the CFTC managed to drive natural gas prices to the low levels that were common in the 1990s. Natural gas was already trading at multi-year lows before the CFTC investigations and half of all natural gas rigs in the U.S. had already been shut down. The impact on natural gas was only collateral damage though from the CFTC's real target, which was oil.

Nothing has a greater impact on consumer prices than does oil and governments know that controlling its price is one of the keys to controlling inflation. Around the same time that the U.S. CFTC announced its hearings, the prime minister of England, Gordon Brown, and the president of France, Nicolas Sarkozy made a joint proposal that an international body of government bureaucrats should set the price of oil instead of the free markets. They suggested the price should be kept in the $70 to $80 range. For those who don't recall, Gordon Brown was the British government bureaucrat that sold half the UK's gold for under $300 in 1999 and the early 2000s. Gold has since quadrupled from the price where he sold it, so the UK didn't get that profit. The U.S. dollars that Brown bought from the gold sale then subsequently lost at least 30% of their value. This is the type of market 'genius' that government brings to the table. Would you like to let a government bureaucrat make investing decisions for your 401K?

The CFTC has more ability to impact oil and natural gas than it does gold and silver. ETFs that deal with energy commodities have to do so through some type of futures trading. Oil and natural gas cannot be easily stored as is the case with gold and silver. While there are ETFs for both gold and silver that only trade futures, there are 11 ETFs globally that buy physical gold. None of them store that gold in the United States. They are beyond the reach of the CFTC and the claws of the U.S. government, which for those who don't remember confiscated all of its citizens gold in 1933 and silver in 1934. In aggregate, the gold ETFs have become the sixth largest holder of gold worldwide since the first one was created in March 2003. They hold more gold than China, but less gold than France. In several more years, they could easily have more gold in storage than any central bank.  

Both oil and gold are completely international commodities (natural gas trades in regional markets). If regulation becomes too onerous in the United States, trading can and will shift elsewhere, just as trading in ETFs will shift from those that invest with futures to those that hold physical metal. When the CFTC made its announcement that it would be investigating gold and silver trading, the London Metal Exchange said it would offer clearing for gold over-the-counter (OTC) contracts in London by the second half of 2010. Hong Kong, Singapore, Zurich, Sydney, Tokyo, and Mumbai would probably like to have the trading business too if it leaves the U.S. commodity markets. The CFTC's action is just another government- motivated attempt to prop up the U.S. dollar by trying to hold the price of gold down. It won't work. The CFTC doesn't have the power to make it happen. Prices will eventually have to move to the point that the market dictates, just as they always do. 

Disclosure: Long gold and silver

NEXT: Lessons for Investors from the U.S. Senate Race

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Government Price Controls in the Making

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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British Prime Minster Gordon Brown and French President Nicolas Sarkozy had a article in the Wall Street Journal yesterday entitled, " Oil Prices Need Government Supervision". In this article they recommend that "the Expert Group of the International Energy Forum take the lead in establishing a common long-term view on what price range would be consistent with the fundamentals." They claim at many points in the article that producers and consumers benefit from price stability and the hand of government is needed to assure this. Obviously, their knowledge of history doesn't extend beyond yesterday's lunch.

The Brown/Sarkozy idea was tried on a mass scale in post-war communist Eastern Europe. The government kept prices very stable. That consumers benefited from the chronic shortages that resulted is doubtful. Industrial production was highly inefficient and ultimately fell apart. Some of the worst hyperinflations in history followed in the 1990s. Yes, there is certainly a lot of evidence from the real world that 'government supervision' of markets works well. Brown and Sarkozy hope to bring these benefits to YOU. Note to Brown and Sarkozy: There is already a mechanism for finding the correct long term price for any item - it's called the free market. Just because you don't like that price, doesn't mean it's the wrong price.

Unlike price controls, which is what Brown and Sarkozy are recommending even though they didn't use the term in their article and which NEVER work, there are solutions to the problems they have with the price of oil. Businesses and consumers are paying too high a price in their countries? Well they can cut the extremely high taxes that their governments place on fuel. The price of oil is going up too much. Well, stop letting it be priced in U.S. dollars or tell the U.S to stop running $2 trillion budget deficits and engaging in money printing through quantitative easing. Mr. Brown should follow this advice himself, since Britain is in possibly worse financial shape than the U.S. Don't expect any of these solutions that would actually solve the problem to be implemented though. That would require some real leadership. It is much easier to blame speculators for prices rises and this is the tack the governments have always taken throughout history.

Why should anyone listen to Brown or Sakozy as is? Do either of them have any record of economic success? I don't recall reading about any French 'economic miracle' in the last few years. As for Brown, he was the one that sold half of Britain's gold for $260 an ounce in 1999 and then bought a big chunk of U.S. dollars with the proceeds. The dollars lost a lot of their value subsequently while gold prices were rising to a $1000. The man is obviously an economic 'genius'. Britain also had a worse subprime housing crisis than the U.S. Banks there gave 125% mortgages to people who couldn't pay them back. When someone has done stupid things over and over and over again, it is generally a good idea not to follow their advice.

Nevertheless, you can safely assume that price controls will eventually be implemented because governments that create inflation are governments that try to take the easy way out. You can also safely assume that they will cause shortages. You can also safely assume that prices will subsequently rise much higher than anything previously imagined. You can also safely assume that if Western countries clamp down on free market trading, it will simply move elsewhere (to Dubai, the Far East or possibly any number of offshore money havens). Governments never learn and Brown and Sakozy's article yesterday is just more evidence that things are not going to be any different this time than they have been hundreds of times before in the past.

NEXT: Energy, Commodities and the U.S. Dollar

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.