Here we go again with the ‘last minute’ concessions…
Overnight, Greece rushed some last minute proposals through the door in what was supposed to be a last chance meeting to gain access to ‘bailout’ funds. But the concessions came too late for Greece’s creditors to make any definitive statement on, so we are again left hanging…
This didn’t stop markets from rejoicing though. Germany’s DAX index finished nearly 4% higher overnight. Greece’s main bourse surged 9% while bank stocks rose 20%!
Seriously, who’d want to be an investor in Greek stocks? That sort of volatility is enough to fray the steeliest of nerves. A 9% surge might sound good but keep in mind the Greek market is down around 45% since March 2014, and more than 55% since early 2011.
Despite the monotonous headlines of hope over the past few years, the Greek stock market is much more equivocal. That is, it’s telling you that there is no hope. A near 50% decline in just over a year tells a story of an economy in depression, choked by austerity and an uncompetitive exchange rate.
It’s true that Greek stocks could turn out to be a bargain at these levels. But the market is certainly not showing any signs of a turnaround yet. Sadly, there looks like nothing but pain on the horizon for Greece.
Staying with the euro means many more years of austerity and recession-like conditions. Leaving means a massive loss of asset value relative to the rest of Europe via currency depreciation. Pick your poison…
If you want to get down to the real cause of this ongoing Greek/euro crisis, you have to go all the way back to 1944. Actually, you could go back to 1922 and the Genoa Conference, where the Allied powers got together to work out a post-war currency regime.
While I won’t get into it what went wrong at Genoa here, let’s just say it enabled a vast expansion of credit that eventually lead to the 1920s boom and subsequent bust in 1929 and beyond.
Anyway, in 1944 the Allied powers met again to devise a post-war currency system. As the US was the dominant power, the system they devised, known as the Bretton Woods currency regime, placed the US dollar at the centre of the currency universe.
This system provided the US with a massive advantage, or an ‘exorbitant privilege’ as French Finance Minister of the 1960s, Valery Giscard d’Estaing, referred to it. The French especially, and the Europeans in general, weren’t happy that the new currency regime, with the US dollar as the world’s reserve asset, allowed the US consume European goods by printing money.
As a result, the Europeans embarked on the long and arduous process of forming its own currency union, as a rival to the US dollar.
It took a long time, but in 1999 the euro was born. However, there was a fatal design flaw. The euro nations didn’t agree to consolidate their debts. Unlike in the US, there was no Federal debt market, and no way to legitimately bail-out indebted or bankrupt states, as Greece clearly is.
That’s why this ‘rescue’ has been such a debacle. It’s the product of a flawed currency system that didn’t envisage such a crisis.
But the Greek crisis is just a microcosm of what’s happening across the globe. That is, a US dollar based international currency system has caused vast imbalances over the past few decades.
The market saw fit to resolve these imbalances via the credit crisis of 2008. Only historic and prolonged intervention by governments and central banks put the unstable system back on track.
But for how long?
The global economy is only limping along due to ongoing central bank management of the financial system. As soon as this support goes, my guess is that the system will crash again.
Which makes the whole Federal Reserve interest rate raising exercise a critical one. Will the Fed even be able to raise rates? Or will they be able to get away with one or two before major stress reappears?
Who knows? With the Bank of Japan and the European Central Bank still deep into their QE experiment, perhaps the Fed has a reasonable amount of wriggle room?
James Rickards, editor of our newest advisory, Strategic Intelligence, thinks not. He’s tipping US interest rates won’t rise for a long, long time. That means we could get this uneasy, ‘hated’ global bull market in stocks for years to come.
One thing is for sure, these flawed currency systems we’re living with will continue to produce tremors and volatility. The next tremor might not be far off.
The International Monetary Fund (IMF) will later this year announce a reweighting of the basket of currencies that make up its ‘Special Drawing Rights’ (SDRs). These SDRs are like another reserve currency, available to any nation that wants to swap a currency into a more secure basket of currencies.
For example, if the majority of your trade is with Indonesia, you might not be comfortable holding a growing pile of rupiah. Instead, you can swap it for SDRs, which are made up of US dollars (66%) euros (42%) yen (12%) and British pounds (11%).
Probably the biggest beneficiary of this structure is the British Pound. Britain’s economy only accounts for around 2.75% of global GDP. Its place in the SDR creates much more demand for pounds that otherwise would be the case. In turn, this allows Britain to borrow and consume much more than it ordinarily would.
There is increasing pressure for China’s yuan to be a part of the SDR. Given that its economy accounts for around 16% of global economic growth, you’d think this will occur.
When the IMF looks at reweighting the SDR currency basket later this year, it will set off another round of currency volatility as the market adjusts. I wonder if it will be the catalyst for sending the latest crisis from Europe to the UK?
For Markets and Money, Australia