This isn’t the Junior Common Room, Yanis, says Dawn Kendall Senior Bond Strategist at Investec Wealth & Investment.
The new regime in Greece would like to consider that they have brought about a revolution in all but name. The anti-societal academics have won an election on the basis of change and promises to ease the pain of the population who are paying for the profligate lifestyle that cheap money under loose fiscal policy provided prior to the crisis.
At the present time, Greece is on life support provided by the ECB via the Emergency Liquidity Arrangement. This is similar to the discount windows provided by the Bank of England and the Federal Reserve for banks. For example, it is now a badge of honour for Deutsche that they did not need to apply for help during the crisis. In a similar way, the Greek government are able to issue T Bills because they are allowed relief via the liquidity facility, they pass this on to the banks allowing them to keep the banking system functioning. The ECB only allow this window to remain open if the government can post investment grade collateral or the country is subject to the Troika plan. If Greece withdraws from the Troika, the money stops, meaning that the Greek government defaults and the banks fail. This risk is notably expressed in the yields offered on Greek bank bonds. Despite these higher yields, we still think it is a far too volatile situation to recommend investment.
However, we should remember that Greek debt is a total of Eur315bn and tiny in comparison to the Eurozone total of approximately Eur5trn. Risk of contagion has lessened over the last two years through the strengthening of bank balance sheets elsewhere in Europe and the efforts of peripheral European governments to mend their economies. Italy and Spain do present a risk but a marginal one. The ECB and the Commission are thoughtful organisations who will have made meticulous plans regarding various outcomes to present events. It is not a coincidence that Draghi’s QE announcement last week has given the market an ample risk cushion for the time being. So, the impact is now manageable externally; internally it may be a different matter. The risks to the Greek economy have been heightened by the election of a radical left wing party. The game of brinkmanship that we can now observe is a dangerous one, as the ECB holds the greatest advantage.
Greek Yield Curve
In order to understand the stance taken by the new government, it is useful to consider the politicians and their backgrounds in particular the new finance minister, Yanis Varoufakis. He has made his career on a foundation of study of game theory; based on irrationality. He honed his understanding at the hot bed of Marxism, the University of Essex and is also a plenteous blogger http://yanisvaroufakis.eu So, we have a good source of information on his philosophical stance. We have also been given first hand, local evidence of his control over sartorial elegance.
In economics, game theory is used to understand the behaviour of firms in an oligopoly (e.g., OPEC and other cartels), specifically in regards to price fixing, price wars and collusion. Game theory gives economists a way to predict outcomes when firms engage in these kinds of behaviour. But in the democratic process it can be used in a potentially destructive way, political candidates commit to ideologies on a one-dimensional policy space. They converge to the ideology preferred by the median voter if voters are fully informed, but then the model flexes to account for voters remaining rationally ignorant which allows for candidates to diverge from their policy stance. Sounds like a cop out at the very best and at worst, chaos.
Whereas game theory can be irrational, the combined approach of the European Commission, the ECB and the IMF is based upon mainstream economic theory and is rational. In dealing with two entirely different ideologies, it is difficult to see how the two thought processes can be reconciled, as they do not start from the same premise.
The Greeks have prior form in this respect. The Drachma was devalued in 1997, just before the decision was finally made to enter the Euro mechanism. This was “resolved” by a remarkable construct of swap arrangements by our friends at Goldman Sachs. Now, it is the turn of Lazard to advise the government on how best to tackle the stand-off between regional and central control. And their client list reads like a rogues gallery of miscreants and mendicants, Argentina, Iraq, Cote d’Ivoire and er, New York. The Argentinian example is an interesting comparison; tricky politicians without a regard for the basic rule of law used filibuster to try and “shame” bond holders to forgive their debts. The analogy I find it impossible to resist.
Value of Greek Drachma versus the USD – post introduction of the Euro – this tracks the EUR rate. Source: Bloomberg
The net result of these musings is that although the will of the ECB, the IMF and the European Commission should prevail, the path for Greece may be very difficult indeed.
The new politics of Greece is based upon academic thesis – unfortunately, markets are brutal and do not offer the luxury of academic procrastination. Markets like clarity and they like actions that are funded and logical. At present, we have no such clarity and the budget is unfunded. So this niche market, albeit offering eye watering opportunities, is best left to our trading cousins before we can consider it safe enough to invest for our clients.