Tag Archives: Greece

capital flight and brain drain (II): Greece

May 22, 2012 By in capital flight/brain drain, economics Tags: , , , , , , , Leave a comment

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.

brain drain in 2012

November 20, 2011 By in brain drain, China, Current Market Thoughts, economics, Recent Market Action, Strategy Tags: , , , , , , , , , , Leave a comment

what it is

“Brain drain” is a term coined in the UK after WWII to describe the outflow of human intellectual/scientific/economic talent from a country.  Motivation for the outflow can sometimes be religious or ethnic persecution in the home country.  More benignly, brain drain is more likely motivated by economic prospects that are perceived to be significantly better away from the home country.  According to Wikipedia, the term may have been initially used to describe the movement of British citizens to the US, or to the inflow into the UK of citizens of India.

where is it happening today?

What forms of brain drain can be seen in today’s world?

the Eurozone

–I think we should watch the EU carefully, especially southern Europe.  On the one hand, government finances in Italy, Greece… can’t be fixed by raising taxes.  People will move into other parts of the Eurozone, for one thing,  History also shows that higher tax rates invariably trigger increased tax evasion.  So higher rates can end up generating lower revenue.  (This isn’t just a European phenomenon:  New Jersey has just released an economic study showing the state is suffering a net loss of $150 million in annual tax revenues as a consequence of two income tax rate hikes early in the last decade).

Even though cost-cutting will be the main tool European governments will use to balance heir budgets, the economic stagnation that austerity measures will produce may cause an outflow of intellectual talent from southern Europe to France or Germany, or outside the Eurozone to the UK.

the US

–Anecdotal evidence suggests there’s a budding trend toward emigration from the US to China, because of the latter’s superior economic prospects.  There’s also a movement on the Northeast to create publicly funded schools that emphasize Asian culture and history–and where instruction might be in Mandarin.

–a combination of high taxes, lack of home-grown engineering graduates and immigration restrictions that severely limit the number of Indian and Chinese engineers able to work in the US has meant a continual outflow of technology manufacturing away from the US.

China

–To my mind, the most curious case of potential brain drain is that recently reported by the Wall Street Journal.  It’s the potential outflow of wealthy Chinese from the mainland.  They’re not seeking political or economic freedom, or at least not simply that.  What’s prompting them to consider emigration–overwhelmingly to either the US or Canada–are social concerns, including:

–poor schools

–bad medical treatment

–pollution

in that order.  Also:

–unsafe food (local municipal authorities sometimes offer industrial waste disposal sites for lease as agricultural land), and

–the one-child policy.

investment implications

At this point, these developments are more curiosities than anything else.  But events in southern Europe bear close watching.  That’s the place where emigration has the most potential for economic disruption, in my opinion.

the EU financial crisis won’t be over any time soon

November 18, 2011 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , , , , , 1 Comment

how the EU got into this fix

1.  For many years the EU ran a money policy that was just right for a Germany struggling with the integration of the former East Germany, which had been run into the ground economically during Soviet rule.  But that stance was much too stimulative for peripheral countries like Ireland and Spain.  The extra money sloshing around there found its way into highly speculative real estate.  This ultimately resulted in lots of bad bank loans.

2.  The big commercial banks in the EU served as a dumping ground for large amounts of toxic sub-prime securities from the US.

3.  Rather than recapitalizing its banks in 2009, as the US did, the EU decided to paper over their losses and hope that economic growth would eventually restore the capital the banks had lost.  That has proved to be a big mistake.

These factors have been well-known for years, however.

What’s relatively new is concern about the EU’s “bad boys,”  Greece and Italy.

4.  It took several years of truly heroic economic reform for Italy to meet the minimum standards for approval to enter into the Eurozone.  The other members might have hoped Italy would continue to strengthen itself once it was in.  But instead, Italy used the borrowing power of the euro to avoid any further adjustment to a fast-changing world, preserving an increasingly non-competitive status quo by running up excessive government debt.

In hindsight, Greece seems to have gotten into the euro only because all parties decided to pretend it met the minimum criteria.  Once in, Greece borrowed up a storm and lied about it for close to a decade–both understating the amount of debt it was running up and overstating its economic growth.  That deceit ended only when a new party took power in Athens last year.  If that weren’t bad enough, the big EU commercial banks appear to be on the losing side of billions of euros of Greek credit default swaps.

where we are now

Greece

The EU and the IMF are trying to arrange a partial bailout of Greece.  They’re doing so in a way they think will avoid triggering the CDS payout provisions, even though Greece will only have to pay back half of the face value of the bonds it has issued.  This is not a move calculated to win friends (or trust) among those who have been betting on Greek default, implying that the amounts are large enough that the banks can’t afford to pay.

The big question is whether Greece will go along with the austerity measures the IMF is proposing in exchange for debt forgiveness.  Another new government is in place.  It’s made up of “technocrats,” which means roughly that they’re supposed to wield a cost-cutting axe and then withdraw from public life.  But will Athens actually do any of the things it has promised?  No one knows.

The EU is simultaneously preparing Plan B, which would be to expel Greece from the euro.

Italy

Greece is poor and too small to matter.  Italy, on the other hand, is wealthy and too big to fail.  Italy, too, has just installed a new government of “technocrats.”  It has also successfully gone through a severe restructuring in the past, just to get into the euro in the first place.  So history says Italy can (and will) do so again.

my thoughts

Good news on restructuring in Greece or Italy will be slow in coming, because political processes take time to work out.  Bad news, on the other hand, like that Athens refuses to do anything, tends to surface right away.  Because of this, I think the news flow from the EU for the next few months will be generally neutral to negative and will be a net drag on world stock markets.

My guess is that markets are now almost fully discounting the possibility that Greece will leave the euro and that Italian economic reform will be slow but ultimately successful.  For what it’s worth, that’s also my base case.

I’ve argued in previous posts that the EU as a whole is already small enough in world terms that its likely economic performance isn’t enough to move the global needle one way or the other.

The real worry for non-EU investors is that failure of a large EU financial institution as a result of the EU’s cumulative problems will happen–and that this will have a Lehman-like negative effect on world trade.  I think this outcome is highly unlikely.

If that’s correct, we have two potentially negative influences from the EU to deal with in the coming months:

–uncertainty about Italy, and

–bouts of panicky selling by Europeans, for whom the crisis is far more important than it is for the rest of the world.

On the other hand, I agree with Goldman that a self-sustaining economic recovery in the US  is already underway.

My conclusion?  …avoid the EU for now and watch for potential weakness elsewhere to upgrade your portfolio holdings.

Europe’s deal on Greek debt

October 27, 2011 By in Current Market Thoughts, economics, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , , , , Leave a comment

the Greek sovereign debt deal

Europe appears to have reached another milestone in its circuitous journey toward resolution of its twin debt crises–Greece and its banks’ unknown, but presumably very large, exposure to sub-prime mortgage debt.

Yesterday’s development is that commercial banks in the EU have agreed to “voluntarily” agree to forgive half the amount the Greek government owes them and write down the value of their Greek sovereign debt by 50%.

Although sharply higher stock prices in Asia, Europe and in pre-market trading in the US signal investor relief, I don’t think it’s particularly surprising that the banks would accede to the wishes of their governments to do so.  For one thing, defying your central bankers is never a good idea.  But in this case agreement brings tangible advantages to the banks as well.

Press reports have made it clear that, earning once again their reputation as the world’s ultimate “dumb money,” the big EU commercial banks had enabled hedge funds to bet heavily on a Greek default by taking the other side of hundreds of billions of euros of credit default swaps.  So the banks would be facing mammoth losses if Greece defaulted and they had to pay off.

But the EU has found what it considers a loophole in the language of the CDS contracts. Technically speaking, it argues, if creditors “voluntarily” forgive a portion of Greece’s debt–which they have just agreed to do–that action doesn’t count as a default; the CDS payoffs aren’t triggered.

Maybe this interpretation is sound, maybe not.  But it’s what the EU is going to do.  National regulators will certainly order their banks not to pay any CDS claims.  Hedge funds can sue.  Litigation would doubtless be long and expensive, however.  And it would provoke the ire of EU politicians, who might find ways to make litigants’ lives more difficult in other areas.

So the bank agreement appears to make the threat to bank solvency of their CDS exposure go away.

what I make of the EU situation

To my mind, resolution to the EU financial crisis has three possible outcomes:

1.  The Greece et al sovereign debt crisis spins out of control–causing the failure of one or more major banks, a run on the euro and a collapse of the EU political structure.  While this is going on, we discover that one of the now-defunct institutions has a crucial, but hitherto unappreciated, role in world commerce.  So the global economy comes to a screeching halt, just like it did after the Lehman bankruptcy.

There’s no evidence there’s an EU Lehman and it’s hard to believe the world would shoot itself in the foot a second time.  On the other hand, the EU has shown itself particularly ill-suited to deal with a financial crisis.  recent trading show clearly that global equity investors have been worried about this possibility, but I regard Lehman II as about as unlikely as you can get.  It’s even less likely today.

2.  Same as #1, except no Lehman.  That is to say, a big banking failure paralyzes the EU.  Most of the economic damage is domestic.  There are ripple effects elsewhere, but they’re not gigantic.

It seems to me that today’s news is also the start of taking this worry off the table.

how important is the EU?

Sizing the problem in the most simple-minded way (all I’m capable of), the world economy is divided about 50-50 into emerging and developed markets.  Half the developed part is the US and another 5% is the UK.  That leaves 20% for Euroland.

Suppose banking failure(s) caused a severe recession in the euro area.  Real output drops by 5%.  That would reduce total world output by 1% (5% x .2), and developed world output by 2%, in the year following the blowup.  factoring in ripple effects, the developed world would stagnate; the developing world would power along, but a bit more slowly.  The whole world would grow at, say, 2.5% next year instead of 3.5%-4.0%, if the blowup happened now.

…something you’d like to avoid, but not such a big deal.

As surprising as this thought may be to Americans with cultural roots in Europe, Euroland is no longer big enough to matter that much to overall world growth, except in extreme circumstances.

True, Europe has a lot of accumulated wealth–which we’ve seen on display, I think, in the periodic panic selling that has marked the past few months.  But it’s too wrapped up in what looks to an outsider like petty regional politics to focus on getting GDP to expand.  And much of the rest of the world is passing it by.

3.  The financial crisis is addressed, the banks recapitalize and the EU begins to heal its wounds, following the general trajectory of the US economy with a three-year lag.  Dreary as it sounds, I think this is both the most favorable and most likely case.

equity implications

Not much different from what I’ve been writing for a long time.  In cases #1 and #2, equity investors would be better off not holding EU-listed securities and should shade their other holdings away from companies with a large percentage of their business in the EU.

In case 3, it’s safe to dip a toe in the water.  But growth outside the EU will likely be much better than growth inside.  So the relative winners will be EU-listed firms with large exposure to foreign markets.  In a non-recessionary EU, these stocks stand to be winners on the world equity stage as well, since EU investors will likely concentrate heavily on them.