The equity markets seem particularly roiled today as a result of the failure of the ECB and Greece to come to a deal on their debt. While this is great news for traders, as it increases the volatility of the markets, it is really a yawner for longer term investors. Here are several reasons why:
First, Greece is just not that big. To put it into perspective, Greek GDP is in the area of $220 billion. Compare that with the overall size of the Eurozone which is around $12.7 trillion. So in US terms the Greek default is about the same as the Detroit default in the US. Detroit has a GDP of around $200 billion. So no offense Greece, you’re just not big enough to matter.
Second, there is concern that as a result of the default, the US dollar will strengthen relative to the Euro, which will make the US less competitive. While we do agree that rapid currency movement does have a negative effect on economic growth, longer term, the capital moves to where it is needed the most. The US has gone through periods in our history with long term trends of a strengthening dollar. This has brought about greater growth, not less. So short term, we agree, but that is also why we are overweight international equities as they will be the beneficiary in near term. Longer term, this is a positive for US investors.
Third, there is a political concern that if Greece fails, other nefarious countries might take a greater interest in Greek affairs. Perhaps Russia might think it a good idea to help out the struggling nation in return for greater support. While this is an interesting assumption, the developed countries of today do not fight conventional wars, they fight economic ones. This was clearly how the US won the Cold War, through strong economic growth. So inviting a country with economic prospects that are miserable into your fold is not something that should concern the Eurozone.
The real question now is who will cave first and what will be the ramifications. Right now it is not looking good for a solution. If somehow the Greeks accept the EU solution, it will doom the Greek people to a recession that could last decades. If they don’t accept the EU solution, the recession will last longer. There are not a whole lot of good choices for them.
The EU is looking for a combination of lower spending (austerity) and increased taxes. There are those that argue that austerity just increases the chance of recession. This is true, but not lowering spending just pushes the debt calamity down the road. Increasing taxes also is not helpful towards growth, but this one is really a non-starter. Very few people in Greece pay the taxes that they should anyway.
While the solution is simple, it is hard to implement. Greece should clearly never have been allowed into the Euro. Now that they are in, they don’t want to take their medicine for the disease they have been feeding for a hundred years; too much spending with not enough revenue. So the solution is yes, leave the Euro, depreciate a new Drachma, and continue life as it was before the Euro. Unfortunately the Greeks now want the benefits of the Euro, but don’t want to pay for them.
So in the short run, enjoy the show, but don’t take much stock that Greece can fundamentally change the economic course of the Globe.
July 1, 2015