Greece: The correct course of action would be default

Outlook:

We wrote yesterday that a third bad deal is dumb and if the creditors are not willing to offer debt forgiveness, the Germans are right that temporary suspension from the eurozone is not such a bad idea. Debt is reported at 177% of GDP and now the IMF says that extending the existing and new debt out 30 years may still not qualify for sustainability. Financially, the correct course of action is default. Economically, default is a humanitarian disaster but offers the possibility of re-birth. Given the Greek culture, this is a small possibility but it’s not zero. Nobody thinks the Greeks are not smart and capable, but they are ill-served by their governments. Greece needs structural reform in the worst way. Greece needs a Thatcher.

Besides, the chief fear of Grexit is that it will give other members the wrong idea. But if the cost is de-fault-first, sovereign pride will be a high hurdle. Greece would become the poster child for how not to manage your affairs. Parliamentarians will bring it up repeatedly as budgets get debated. This is not a bad thing, especially if it’s true that several countries have a lacksadaisical attitude toward debt.

And the EMU charter is “no bailouts.” Violating that is a really big deal and could do reputation damage to the euro for decades. A third way needs to be found. We have a decent model in bankruptcy policies and procedures for the private sector, but governments are not, of course, companies or individuals. That doesn’t mean a third way can’t be devised. The problem is that it’s awfully late to be re-inventing things now, not when Greece needs €7 billion by Monday. The solution is charity rather than loans to people who will never be able to repay. Maybe combine charity with collateral—an odd addition from the credit world. The EC can take ownership of state assets but deliver charity in proportion to need rather than as a function of the euro value of the assets.

BoE Gov Carney is among the voices starting to echo the IMF—Greece needs debt relief. But so far the need for debt relief is falling on deaf ears. All the same, the finance and economic professionals “should” prevail over the politicians. We expect a flood of proposals to begin any minute. One idea is for a sovereign or two to relinquish its claim on Greece. That might shame the others (and leave Germany and Finland standing alone as the Grinches in the room). As usual, just about everything depends on Merket.

The uncertainty created by the IMF’s ongoing claims of Greek debt unsustainability is what is holding the euro down—and likely to keep it down unless and until we get debt forgiveness, an outright default, or the yet-unknown third way. One third way might be something from Russia, despite denials left and right. We learned in grade school that Russian imperial ambitions are always inspired by the search for a year-round port, and Piraeus certainly qualifies. Or maybe the Chinese or the US could step in. China has the money and the US is deeply committed to NATO. Greece may be small but has the ability to generate big and long-lasting ripples.

Back in the US, today we get industrial production, the Beige Book, and the Empire State manufacturing index. Following lousy retail sales, antennae are up and waving around for any small of lingering recession. The big event will be Yellen’s first presentation to Congress, with another one tomorrow. The speech Friday probably contains all the clues we are likely to get—economy improving, rate hike this year, external events not the ruling factor. Congress wants to roast Yellen over a fire on charges about information leaks and other matters, so her famous composure will be on trial.

We say the need for normalization was never greater. The BoA Merrill Lynch global fund manager survey shows investors are holding more cash now than at any time since Dec 2008. They blame pessimism on Greece and China, but we think they should have noted the peculiar distortions caused by ZIRP and the upcoming First Rate Hike. We would like to hear the word “normalization” uttered by Yellen today.

As an aside, we always joke that when the US is headed for war, the dollar goes up. We don’t understand it. FX traders are not more blood-thirsty than anyone else, so maybe it’s the exercise of global hegemony (or something). Now that war with Iran is off the table, at least for the moment, should we expect the dollar to go down? We don’t know if it’s a symmetrical effect or whether, if the dollar goes down, it has anything to do with the Iran treaty. Remember, the US was not alone in that room in Switzerland.

The old phrase from the hippy-dippy ‘60’s was “give peace a chance.” That doesn’t mean you have to be stupid about it. On the whole, we can’t find anything wrong with the general idea of a treaty that prevents war. That doesn’t make the proponents a Chamberlain. We are supposed to have verification, not trust, since you can’t trust religion-addled people.

We don’t claim to know whether the treaty is a good one, but we do know that leaders need really good reasons to go to war while the reasons for peace lie in Arlington. One small group was dancing in the streets of Tehran. Talking after 60 years (Cuba) or 37 years (Iran) leads to more talking. Maybe this treaty fails but if we are talking, some other deals go forward. Doing the same thing time after time and expecting a different outcome is stupid, or insane.

One possible bottom line out of the treaty is a cut in US dense spending, or at least a slower pace of increase in defense spending. Reagan was the one who started this particular ball rolling, so let’s not mention left vs. right politics. The danger is that the war-mongers might do something stupid like withhold budget and deficit approvals, risking US default, to get their way on the treaty. This is where politics might affect the dollar, but it’s a way down the road and not immediate.

Keep your powder dry. Something is coming, and it might be something we haven’t thought of yet.