three weird things that happened this week

1.  Greece  After months of vitriolic negotiations and after calling a referendum in which it successfully campaigned to have Greece vote against accepting a financial bailout from the EU/IMF, the Greek government appears today to have accepted that bailout.

2.  Chinese stocks  After plunging for a month, Chinese stocks have risen by 10% over the past two trading days.  The world is breathing a sigh of relief.  I’m not sure what’s weirder–that this happened or that foreigners believed for a short while that in a country where doing anti-social stuff can get you either a long prison term or beheading, rather than the cover of Forbes, China would be unable to achieve this outcome.  Actually, the foreign belief is way weirder.

3.  Microsoft/Nokia  Less than fifteen months after acquiring the cellphones business of Nokia, MSFT has discovered that what it bought for over $7 billion (led by mastermind Steve Ballmer) is essentially worthless and is writing off virtually the entire purchase price.  The stock went up on the news.

Which is weirder:  that the MSFT board that rubber-stamped this disaster is still intact?  …or that people are still buying Clippers season tickets?   I suppose you could argue that Nokia was the price for getting rid of Ballmer, which would imply that the behavior of Clippers fans is weirder.

negotiating: Casio, China and Greece

requesting an investment banking client meeting

Years ago, so long ago in fact that Tokyo was by a wide measure the largest stock market in the world, I received a call from a broker asking whether I wanted to meet with the top management of electronics maker Casio in my office in Manhattan the next day.

I knew the company a bit.  I’d visited it in Japan.  It wasn’t a particularly well-run firm.  And it was an exporter, a weak yen beneficiary, at a time when the yen was soaring and only domestic-oriented companies went up.  So I had little interest.

But I said yes anyway.

The broker was in a bind.  He was supposed to be showing Casio the power of his firm’s client list in New York and some manager had cancelled at the last minute, creating a potential loss of face for both the broker and Casio.  I had only a small pool of money under management and my acceptance would obligate the broker to provide me a return service that my commission volume alone couldn’t buy.

Apparently, the CEO of Casio felt under the same sort of obligation.  The meeting was interesting and informative, although it gave me no reason to want to buy the stock.

negotiations with China

The main topic was the company’s negotiations at that time to increase manufacturing capacity in China.

Casio met with Chinese government officials over several sessions and came to a preliminary agreement.  When the two sides met again, ostensibly to cross the ts and dot the is, the Chinese side reopened the negotiations, demanding substantial new concessions.   What Casio expected to be the end point turned out to be the new starting point for further haggling.  It went along because it figured the costs of starting again elsewhere from scratch were too high.

This happened several more times.

Then a contract signing was scheduled.  At that meeting, the Chinese side accused Casio of complicity in the rape of Nanking and demanded still more concessions as a form of reparation.  Casio did so, even though the last contract changes removed all chance of profit from the new plant.

With some distance, the CEO’s main conclusion from this experience was that the long-term relationship of mutual respect and trust that he hoped to find in China was simply not there.  He’d already decided to cut his losses and do no more expansion in China.

Greece today

I was already quite familiar with this negotiating style, which might be described as death (of the other guy) by a thousand cuts.  I’d seen a former boss to the same thing to Lehman.  In that case, however, Lehman eventually picked up and left in disgust.

In its negotiations with the rest of the EU, Greece has been following the same playbook Casio described to me decades ago, down to the accusation of wartime atrocities.  The main casualty in this approach is the loss of trust between the parties, once the Casio-side party realizes the other has no interest in a solution that brings mutual benefit.

It seems clear to me that we’ve passed that point in the Greece-EU discussions.  We’ll find out over the weekend whether this precludes any agreement from being reached.

 

 

 

Greece votes No

Yesterday, Greek voters backed its national administration’s position of rejecting the latest EU bailout conditions in a resounding vote.  60+% of total ballots were “No,” with the nays being a majority in all regions of the country.

S&P futures fell to about -24 when the official voting results were announced shortly before 11pm eastern time last night.  As I’m writing this just before 8am, futures are off by -14; European stock markets are trading lower, but not by much, as is the euro.

Not the best, but not bad, either.

I think what Mr. Tsipras has demonstrated with this vote is that Greece simply will not accept the bailout terms on offer from the ECB/IMF.  Yes, the two sides might sign an agreement, but any Athens government that attempted to implement it would be tossed out of office and replaced by one that would not.

In many ways–and, in particular, from an investment perspective–this simplifies the situation a lot.

 

As I see it, the ball is now in the EU’s court.  It can either make enough further concessions to make a bailout deal palatable to Greek voters   …or it can walk away from the negotiating table, thereby forcing Greece to exit the euro.  The first course presents significant political risks to Brussels and Berlin.  In fact, the Tsipras negotiating style has both brought the idea of further concessions to the point of being at least thinkable and simultaneously made making them much more politically incendiary.  For German voters still paying extra taxes to rebuild the former East Germany, having Ms. Merkel so publicly bested by Mr. Tsipras’ could easily end the political careers of her and her supporters..  I can’t imagine politicians in Ireland, Spain or Portugal who accepted EU austerity regimens faring any better.

We may know which way the EU and IMF have decided very quickly.

Greek banks are supposed to reopen tomorrow, after being shut for a week.  They likely don’t have enough cash, without ECB support, to meet massive demands for withdrawal of deposits that will most likely ensue if those funds haven’t been transmuted into drachma overnight.

 

As an investor, I think Greece leaving the euro today would be the optimal outcome.  This is pure pragmatics.  That way, the Greek crisis would at least be over–for countries other than Greece.  Markets would decline somewhat, sectors would readjust to the new reality  …and then the mind of he market would be on to the next thing.

My guess is that Greece exiting the euro but remaining in the EU will actually be the final outcome.  I also suspect that the process will take longer than just to tomorrow, but that the bulk of the market reaction to whatever happens will take place over the next few days.  The creditors acceding in more than the most superficial way to demands for better terms is the biggest surprise–meaning, least likely outcome–I can think of.

 

What am I doing in my portfolio?

I’m keeping a much closer eye on China (more tomorrow).

I’m watching US trading carefully today.  I’m looking looking for stocks to buy whose prices may be depressed by worries about Greece.  If futures are any indication, I won’t have much luck.

 

 

Greece in a nutshell

Greece joined the euro in 2001.  This gave it the right to print/mint euro currency, as well as to issue Greek sovereign debt in euros.  The second is important because issuing euro debt is like having access to a giant EU credit card–payment was at least implicitly guaranteed by every member of the EU, not just Greece.

Greece probably didn’t meet the criteria of economic health necessary to qualify to join the euro. Everyone in the EU seems to have known this at the time but thought that having the cradle of Western intellectual and political history in the euro was symbolically important.

In 2009, the ruling party lost an election.  The new administration discovered, and announced to the world, that Greece had been systematically falsifying its national accounts–official reports of the country’s fiscal health and growth–for years.  Greece’s apparent prosperity during the opening years of the 21st century turned out to be a combination of lies and living beyond its means, funded by large-scale euro bond issuance.  Most observers agree that Greece run up more debt that it can ever possibly repay.

Negotiations between Greece and its creditors are at an impasse.  Broadly speaking, the EU and IMF want to see structural economic reforms (which may prevent a repeat of the country’s woes) in Greece before any debt forgiveness.  Greece, whose current government has already reversed some of the few reforms implemented over the past six years, wants debt forgiveness first, talks about structural reform later.

The EU put a take-it-or-leave-it offer on the table about a week ago.  The Greek government has decided to call for a national referendum vote on the issue, scheduled for Sunday.  In the meantime, it has shut down its banks, so no one can take their money out of the country.

There are some odd technical issues with the referendum.  For example, one political party is suing to stop the vote, saying it’s unconstitutional.  It’s also coming at the start of vacation season, so it’s not clear whether people can get home to vote, especially with atm withdrawals limited to €60 a day.

Domestic Greek polls indicate that likely voters favor accepting an EU bailout plan by 52/48–even though the administration is campaigning against it.  A “No” vote probably means Greece leaves the euro, and maybe the EU as well.

I have mixed feelings about the negotiations themselves.  On one hand, I’ve got to admire the ingenuity and determination of the Greek side in trying to get the best possible deal.  On the other, everything I’ve I’ve read and heard to make me think Greece regards negotiation as a blood sport.  The point is not to get a fair deal, but to suck the other side dry and toss the husk to the side of the road.  –even a little bit–about the needs of the other side.  It’s turned the negotiations into a fool me once, fool me twice situation, in my view.

I think the current Greek administration may have done a huge amount of damage to the country’s long-term economic prospects by trying so hard.to wriggle out from responsibility for the current crisis.

Ironically, the better outcome for the EU might be for Greece to vote to leave the euro.  The resulting damage to the Greek economy will be enormous, I think.  Seeing what happens will likely silence separatist movements elsewhere in the EU.

investment wildcard: Grexit

My first employer on Wall Street had an unusually aggressive negotiating style.  At one time, a big brokerage firm wanted to buy the company he founded.  They agreed on a price after lengthy negotiations.  Two weeks later, my boss reopened the negotiations and successfully raised the bid.  Then he did it again.

On the day the contracts were going to be signed, he asked for another 5%, figuring, I think, that the buyer would have no choice but to acquiesce rather than see all the time and effort it had put into the deal go up in smoke.

The buyer walked out the door instead.

According to the Japanese companies I’ve talked to over the years, Chinese government officials use the same psychological ploy–agree, let the other side relax and celebrate  …and then ask for more.  The one difference with China is that twenty years ago manufacturing there gave you both a labor cost and a capital cost advantage over making things elsewhere (the only instance of this I’ve seen in thirty years as an analyst).  So there was no question of going elsewhere.

From my casual observation, Greece has been using this same negotiating style with the rest of the EU over the past few years.  I suspect, however, that Greece’s position is closer to that of my old employer rather than China’s.

How so?

–Greece is small, representing only about 3% of the EU’s GDP.  Arguably, the most important thing it brings to the union is the cachet of once having been the cradle of democracy.

–EU financial institutions are much better able to withstand the shock of a Greek exit from the union than they were in the depths of the financial crisis.

–Greece has complied with virtually none of the dozen-plus structural reform mandates required by the current bailout, which expires at the end of this month.  This gives the EU no reason to believe that Greece will follow through on any terms it agrees to now

–allowing an unrepentant Greece to remain in the EU under far more relaxed standards than afforded to, say, Spain, could easily prove more destabilizing to the EU than cutting ties

–the negative economic consequences for Greece of Grexit could be enormous–enough to provide a cautionary example for other states, or regions within states to reconsider separatist movements.

my take

I think Greece is holding a much weaker hand than is commonly perceived.  I think that the chances Greek government negotiators will take the one step too far that will cause the other side to leave the room are significant–although I have no idea how to quantify that.  Finally, I think any negative reaction to an actual Grexit, ex Greek stocks, which I imagine would do very poorly, would be shorter and milder than the consensus thinks.

capital flight and brain drain (II): Greece

what would Greek exit from the Eurozone look like?

I mean what happens in general terms, not the nitty-gritty details of how a sovereign debt default and currency devaluation would be put into place.

Several things would occur, I think:

1.  Greece would stop making principal and interest payments on its sovereign debt and open negotiations with creditors for new, more favorable, terms.

2.  The country would force conversion of all cash held by Greek citizens or Greek companies into a new currency–call it the drachma.

3.  Greece would prevent reconversion of drachmas into foreign currency.  It might ban citizens from holding foreign currency outright, for example.  It would certainly make it illegal for anyone to transport foreign currency in and (especially) out of the country.

4.  It might institute a crawling peg (a specified daily weakening of the exchange rate) or some other mechanism for continuing devaluation of the drachma vs. the €.

how would Greek citizens react?

This default/devaluation path is well-defined.  Look at Mexico in the early 1980s as an instance.  Knowing the roadmap far in advance, what can Greek citizens do to defend themselves against loss of wealth?  Again, the moves are pretty standard:

–move cash holdings to a bank outside of Greece

–raise cash locally–either by selling assets or by borrowing from a local bank (in the hope that your debt will subsequently be devalued)–and move that out of the country, too

–emigrate.

Businesses would presumably be thinking of similar measures.  In addition, they would likely begin to drag their feet on paying for stuff bought from Greece, while accelerating payment deadlines for Greek customers.

what about investors?

They do pretty much the same.  They extract cash.  They stop making new investments.  Yes, they study what they might like to buy once devaluation occurs, but otherwise they sit on their hands.

taking a very long time…

…makes the situation worse.  While uncertainty remains high, an increasing number of citizens are likely to make and execute capital flight plans.  And the flow of new investment in the country drops to a trickle.  So the country sits in neutral and idles.

effects on the rest of the EU?

I perceive a sharp difference between the local reaction to debt problems in Italy and Spain, on the one hand, and Greece, on the other.

I think the former two have made it clear they accept responsibility for their weak economic situation and are taking action to fix their problems as quickly as they can.  In contrast, Greece seems to me to believe that its sovereign debt is basically an EU problem.  Its strategy appears to be to implement no reforms and instead bargain for ever better terms.

If that’s an accurate representation, one could argue that the contagion effects–the adverse impact on Spanish and Italian bond markets–of Greece leaving the Eurozone (and, presumably the EU) shouldn’t be severe.

In an investment world dominated by short-term chart-oriented traders, however, I don’t have a lot of confidence other investors will see things my way.  I certainly wouldn’t want to bet the farm that I’m right.