MMMM…Greek Coup?

May 31, 2011

Global Macro

Greece is careening toward some sort of resolution, good or bad, and the consequences are not yet known or knowable. For the markets I wrote last week that I thought the recent volatility could be a good thing because it stops what I think is one of the most dangerous thing in markets – correlated bets.

That is, when things are stable and easy (from a market sense not an economic sense) traders, hedge funds and other punters tend to end up with the same bets on. For example everyone is short USD’s and buying high yielding currencies or everyone is short volatility and so on. When something comes along and destabilises the equilibrium then the down side of these trades is in evidence – as everyone heads for the exits trying to get out of the same trade. It’s why AUD always gets hit hard when things go awry, it is the world’s favourite currency punt.

So in some ways the recent volatility is good for the markets in a way that the lead up to the Lehman Bros, collapse was not.

BUT a disconcerting black swan may have just landed on the lake. The father of Black Swan Theory, Nassim Nicholas Taleb says that a Black Swan,

refers only to unexpected events of large magnitude and consequence and their dominant role in history. Such events, considered extreme outliers, collectively play vastly larger roles than regular occurrences

So while we all know that greece is likely to default in some form news coming out of Germany and Turkey about a CIA report on an increased chance of military coup in Greece has to qualify as a Black Swan.

We picked the story up in  “Hurriyet” which calls itself “Turkey’s English Language Daily” but it is a re-publishing of a story in Germany’s BILD tabloid. Clearly we have some self interest here in the historical Turkish antipathy toward Greece and the fact that the original report was in a tabloid but a coup would not be without historical precedent. Anyway the story says,

The U.S. Central Intelligence Agency warned in a report that the tough austerity measures and the dire situation could escalate and even lead to a military coup, according to a report by Germany’s popular daily Bild.

According to he CIA report, ongoing street protests in crisis-hit Greece could turn into escalated violence and a rebellion and the Greek government could lose control, said Bild. The newspaper said the CIA report talks of a possible military coup if the situation becomes more serious and uncontrolled.

 It seems inevitable to me that at some point one of these nations is going to repudiate their debt burden. It has been thus through history and even though we have the EU, Euro and Eurozone it is still Greek (and Irish and Portugeuse etc) citizens and governments that will have to pay this debt off over the next few generations. History says it’s either repudiation or inflation as the way out.

Take the UK for example, the BOE is pursuing inflation to inflate the nominal economy and thus reduce the real value of debt – it’s a stealth default if maintained for a few years. But no less of an effective default as the bond holders lose the real value of their debt. Greece, inside the Euro does not have this option so can not pursue a “British Solution”

Anyway regardless of whether the rumours are true or not about the CIA analysis of the chances of a Greek coup what they mean is that things are getting so bad at the moment and the risk of a big hard default so high that even moribund European politicians will have to act.

To this end Wolfgang Munchau wrote a really good piece in the FT yesterday where he essentially made this point saying that the stand-off between the EU and the IMF must be resolved in favour of more Greek aid otherwise we are looking at 50-70% haircuts for bond holders.

There is one element of good news about this stand-off. It ends the quite dangerous illusion of soft options. Until recently the EU has wasted precious time with a discussion of silly schemes such as soft restructuring, or reprofilings. These would have made no difference to Greek debt sustainability but would carry their own inherent risks. The IMF’s hardline position has at least shown the Europeans that they cannot muddle through this crisis with half-hearted schemes. The policy alternatives are becoming increasingly clear. Either the EU/IMF continues to bankroll Greece for as long as it takes, or Greece will be forced into a hard default. There is no middle way. Some form of private sector involvement is likely, even desirable for political reasons. But it will not be material in terms of a reduction in the net present value of Greek debt.

A default would mean an average haircut of 50 to 70 per cent. I suspect foreign bondholders might face a near-total loss. In that case, the probability of Greece leaving the eurozone must be high.

Munchau is without doubt the thought leader on the Eurozone crisis globally and he sees default as inevitable as do we here at Lighthouse. There is little chance for Greece to shake off its burdens without some kind of default and inside the Eurozone it can’t choose inflation as the UK is.

Munchau says (my bolding),

If Greek politics interferes, all bets are off. Material noncompliance with the EU/IMF programme will always trigger a default. The price for continued support from the EU and the IMF is a quasi loss of economic sovereignty on the part of Greece.

I suspect that the Greeks will continue to accept that trade-off, given the alternative. But nobody can be sure. The IMF has acted as a referee in the process, keeping everyone on course, the Greeks but also the volatile creditor countries.

Of course, the time will come when this game has to stop. I guess that will be sometime between 2013 and 2016. Greece and possibly other countries of the eurozone’s periphery will then have to default but the main creditors left by then will be EU governments and the IMF.

And that’s where we tie back to the Turkish story of the German story of the American CIA analysis – Chinese whispers it may be but the risks of something that we haven’t all thought of happening is still out there in the unknown.

Instability is never good. If we are close to any resolution then this is likely to be really well recieved by the markets. I’d expect a relief rally in risk assets. The closer we get to the precipice in Greece the closer we probably are to resolution and rumours in Asia this morning are that Munchau has hit the mark and a next package is on the way. Relief, until the next time!

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