European Kool-Aid: Greece (again?)

February 17, 2017 09:43 AM

It all has a sense of déjà vu… again on another round of Greece needing more financial support to avoid debt default. That is a recurring nightmare which revolves around the European version of the Kool-Aid Crisis in America (see our Jan. 23 post, “Kool-Aid crisis” in America). While the highly partisan divide in the U.S. seems to only be getting worse and worse on the Left’s resistance against the Trump Administration, Europe has had its own ongoing state of denial. While we will briefly revisit the U.S. equities technical trend view below, it is important to note that while the equities rally will likely maintain there is a recurring sideshow which might cause some near term concern.

Lack of debt relief

That is the return of the Greek Debt Dilemma. Yep, it’s baaaaack! And the same sort of lack of consensus on the most critical steps to finally address it remain the same. After all of these years it would be reasonable to think the IMF and the EU powers-that-be might have resolved their differences on the need for more extensive Greek debt relief.

Ahhh, not so. While there are many opinions about this, our view is that the more parsimonious Euro-zone members fail to appreciate the benefits of further relief for Greece, and in any event have made those steps politically unpalatable.

European Kool-Aid

That gets back to the original European Kool-Aid (i.e. belief in a particular point of view regardless of how indefensible it might be.) This was their conceit that only the American ‘cowboy’ financial system could have allowed anything as stupid and damaging as the related Credit and Housing Bubbles and subsequent 2008 Bust and Crisis.

This is why they have never been able to allow that their system had produced similarly profligate lending, which has never been admitted by their banks in a way that would allow the write-offs of their bad loans. That could have led to the more major recapitalization the American banks pursed on their way back to health.

The Europeans chose instead to shore up the bad loans, which has in turn left their banking sector burdened with the additional drags from that dead weight. While this varies between countries and banks, it is the general tendency that has also suppressed economic growth in Europe. And among the worst of the profligate lending was the extraordinary level of funding provided the Greek government through its bond offerings that were obviously going to be unpayable at some point.

Iron-clad sovereign debt?

Yet the European banks kept lending under the false assessment that this was still "sovereign debt", and there was no way there would be a default by a Euro-zone member. Guess again. This was in its way no better than the mindless American reliance on the idea that U.S. housing prices would always only rise. That laid the foundation for the acceptance of all manner of unsupportable debt that got rolled into all of those toxic Mortgage Backed Securities and other exotic instruments.

That was the American Kool-Aid of the moment that got force fed to much of the rest of the global financial system from the middle of the last decade. The European Kool-Aid has evolved across time. That was from the idea there ever was a ‘Greek bailout’ from the recognition of the crisis back in 2010, evolving into the "Greece is fine" mantra the more parsimonious members of the Euro-zone need to adopt at present. That is due to the political contingencies in their countries rather than any realistic assessment of the state of Greek finances and its overall economic condition.

The Greek Non-Bailout

In the first instance, there never was a ‘Greek’ bailout. The funds provided to Greece back in 2010 and subsequent were reviewed in a Financial Times editorial last Friday. It noted they were more so structured to address “…the political need to shield first their banks and then their taxpayers…” And as part of saying that the provided funds were sufficient they have “…consistently signed up to hugely over-optimistic growth and surplus targets rather than accepting the need for more external finance and, if required, debt writedowns.”

That’s the European Greece is fine Kool-Aid. The lack of appetite for any reasonable further Greek debt relief is directly proportional to two instincts on the part of the creditor nations. In the first instance there was from the beginning a heavy sentiment that the Greeks had been living way beyond their means due to the easy credit conditions Euro-zone membership had afforded them. And this was true to a goodly degree. Yet once that outsized (i.e. likely unpayable) borrowing was clear, there was also nobody putting a gun to the collective head of the major Euro-zone banks who were investing in the ever-expanding Greek government bond offerings.

As they say, "it takes two to tango." Yet the alleged bailouts were geared toward defending those banks’ balance sheets more so than providing any relief to the Greek people to allow a buffer against the austerity that was demanded as the price of the financial support. And over the past six years Greece has been ‘austeritied’ into oblivion, as the second instinct was to punish the Greeks for having been so profligate. Yet there is now little left to create the growth that will support the significant debt Greece still owes.

It gets worse

In fact, the recent news has refuted the ‘Greece is fine’ Kool-Aid. The assertions by the Kool-Aid drinkers into last weekend was that the Greek economy was growing again, and it was the beneficiary of substantial EU lending that the IMF failed to fully take into account. And due to that the IMF was misguided in its analysis of the need for further debt relief it has been demanding for over a year now.

The risk is that the IMF will refuse to participate in any further financial aid if the debt forgiveness is not forthcoming. In turn, the Germans have said they will not proceed without the IMF involvement. Quite a little Gordian Knot.

More Relief Likely Required

Yet the case for more relief for a Greece that has been beat down to the point where recovery of its economy to anywhere near the growth necessary to support the debt load got some unexpected support since discussions late last week. Support that is in the form of troubling economic indications. Earlier this week the Q4 quarterly growth figures were down 0.4% after adding 0.9% in Q3. This points to the Greek economy both slipping back into weakness and not getting any benefit from the prospect of additional bailout funding. And in the latest disputed assessment, the IMF revised it 2017 growth forecast down to 1.0% from 1.5% previous.

This will only exacerbate its disagreement with the ‘Greece is fine’ Kool-Aid drinkers. It is very consistent with the rolling previous errors over the past six years that the creditors have had to revise downward overly optimistic (i.e. self-serving) Greek growth estimates. And this year is no different as the EU is projecting a Greek growth rebound to 2.7% (??!) from just 0.3% in 2016. That must be some pretty strong Kool-Aid.

More bad/good news

Yet there was further bad news on Wednesday. Greek annualized inflation surged to its highest in five years. That will also be a headwind to any sustained growth with the further austerity measures being contemplated as part of the price for that next round of bailout funding. In line with the inflation upsurge across the Euro-zone over the past few months, Greek CPI rose to 1.5% in January from just 0.3% the previous month.

The powers-that-be in the EU can spin fairy tales all that they want, yet none of it will make a difference to the still extremely damaged and weak Greek economy. It still shows no sign of real sustained recovery, and likely needs some further extensive debt forgiveness to have a chance to restore the sort of growth that will actually bring its debt down to serviceable levels… not to mention restore any sort of quality of life to the Greek people. And a major part of the problem remains the political context in the major European countries facing critical elections this year, especially Germany.

How Quickly They Forget

The term ‘quickly’ is admittedly a bit tongue-in-cheek, yet there is an important lesson the most important creditor in Europe (Germany) seems to conveniently, consistently forget. As we noted as far back as our Commentary: Will a European recession spill over into the rest of the world? October 2014 post, Germany was the beneficiary of major debt forgiveness after WWII. To wit…

“In the first instance of German disdain for all of the other Euro-zone members who have not been successful in getting their fiscal house in order, there is historic precedence for debt forgiveness being the path to economic recovery and ultimate strength. The term ‘quickly’ in the title of this section is a bit tongue-in-cheek, as the London Debt Agreement negotiation which assisted German recovery actually occurred in 1953.

“Yet even more than a half century later, the same principles apply. And Germany would do well to recall that its debt from before and after the Second World War was cut in half. That reduced it to 15 billion Deutschemarks, and stretched it out over 30 years. It was thereby down to manageable levels compared to the fast-growing German economy. It seems that Germany should be willing to see similar actions taken to reinvigorate the rest of the European economy, which would obviously benefit its strong man to a significant degree as well.

“And continuing to hamstring the ECB’s efforts to use monetary policy as at least a balm to keep the wounds from going from bad to worse is very counterproductive. It is not just fringe states demonstrating that fiscal rectitude cannot be achieved in a recessionary environment, as France and Italy have both indicated they cannot meet current fiscal goals. Any reasonable assessment of the situation would highlight the degree to which continued austerity risks full blown recession.”

IMF now more so than ECB

The difference now is that the ‘Greece is fine’ Kool-Aid drinkers’ issue is with the IMF’s rightful insistence on debt forgiveness and not the ECB’s monetary largesse (even though they consistently still complain about the latter.) We can also revisit two more points. The first is that Italy is also still not likely to sustain the Euro-zone fiscal requirements across time, and the second is that the 1953 London Agreement debt relief for Germany was an obvious fillip to post-WWII efforts to counter the Cold War Communist threat.

Nobody imagines anything quite like that is required at present. Or is it? The current expectation is that a more centrist, supply-side policy (lower regulation and some tax relief) government will replace Syriza if the economy remains weak. Yet it is a good question how a previously heavily Socialist Greece will respond if the economy does not recover (or sinks even further) across an extended period of time.

Larger than expected political risk?

Have the EU powers-that-be even considered the downside of another Euro-zone defection after the UK EU Brexit, and what it would mean to have a hostile, renewed Socialist/Communist Greece off its southeastern flank? That’s obviously not for next month or maybe even next year. Yet across time it is important for the EU and Euro-zone to consider history, and what it might mean for a future where a reinvigorated Russia has proven so adept at expanding its influence.

As George Santayana cautioned, “Those who cannot remember the past are condemned to repeat it.” Is a potential return to the long troubled Greek penchant for Socialist government and foreign policy really worth whatever might be saved by refusing it the debt relief it so obviously needs?

Brief Market View

▪ Due to sustained aggressive increases in weekly MA-41 (as it loses old lower Closes from the early 2016 selloff) March S&P 500 future extended weekly Oscillator levels are back to moving up roughly $7 each week.  And in line with overrunning higher weekly Oscillator resistance in the 2,289-94 area last week, that rises to 2,295-2,300 this week. Of course, it is also now support around the previous January 26th 2,299.50 all-time trading high that will maintain into next week. 

More important at present is that the extended weekly Oscillator resistance above 2,300 area is 2,332-37 this week that has already been exceeded, yet which rises to 2,340-45 next week. The challenge for the U.S. equities into Friday is whether the March S&P 500 future can indeed maintain the bid above that next week projection. If so, the ultimate Oscillator threshold is up into the 2,370-75 range (weekly MA-41 plus 190-195) next week.

Thanks for your interest.

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About the Author

Alan Rohrbach is Lead Analyst and President of Rohr International, Inc.  He is an international equity index, interest rate and foreign exchange trend advisor. His forte is ‘macro-technical’ analysis of how fundamental influences blend with technical aspects to drive trend psychology. Clients include international banks, hedge funds, other portfolio managers and individual traders.