Here we go….
  • March 16 was a deadline for Greece to update the EU finance ministers on their progress to bring down their deficit this year.
  • March 17th:  the most important person in Europe right now -Angela Merkel  (the German Chancellor – the leader of the German federal government) gave a statement indicating the Eurozone must change its own rules to permit the block to remove a member that repeatedly fails to comply with EU fiscal rules. This would require unanimous support by all 27 member countries including the PIIGS (not likely).
  • March 18th: Merkel indicates IMF should get involved. This essentially calls Greece PM’s bluff of calling in the IMF.
  • March 23rd. Germany issues a press release indicating that any bailout of Greece will happen ONLY if Greece cannot sell its bonds, the IMF would need to be involved, and the EU would need new rules for enforcing deficit limits.
  • March 25th.
    • Prior to the 2-day 27 member EU conference in Brussels (March 25-26), Merkel reiterates Germany will not bail Greece out unless the IMF is involved and default is imminent.
    • A mini summit of the Eurozone heads of state is cancelled at the last minute because of an inability to get Germany and France to reconcile their positions on Greece.  The Eurozone is the 16 member countries within the European Economic Union (EU) that use the Euro as currency.
    • In order to prevent a panic, the European Central Bank (ECB) President steps in and indicates the ECB will continue to take Greek Bonds as collateral for loans even if their credit rating drops. This is very important — and is a reversal of their stated policy on quality of collateral. Without this statement, there would be no buyers of Greek debt and we’d be staring at a default.  This is a game of chicken worth Trillions of dollars / euros.
    • France & Germany reach agreement on the broad terms of a Greek bailout. It necessitates the IMF. In order for the IMF to get involved it will probably insist that Greece drop the Euro and go back to its own currency. This has not
  • Greece needs to roll-over 18B Euro ($24B) in debt in April-May –beginning in 3 weeks from now. So the next 3 weeks are going to see immence pressure on Germany to cave, and on Greece to get their ducks in a row with the IMF. 18B Euro is about a third of their bond sale needs for the year.
What may happen next (I wrote this before the news broke a few hours ago, but sheds light on the options. Looks like I handicapped it right. ) …
  • A bailout (loan guarantees) from Germany, France and other EU members— with no IMF involvement. I give this a 10% chance of happening because Germans head to the polls in May for interim elections. Germans are overwhelmingly opposed to a Greek bailout. Plus Germany is facing its own issues in terms funding welfare programs facing insolvency.
  • IMF loans alone. I give this a 10% chance because the French are too proud to allow the IMF to manage a Euro-zone crisis. The IMF is still viewed as a US-centric policy organization. This is unattractive to the French.
  • A Combined Euro-zone bailout + and IMF loans. 30% chance. But I doubt the Euro-zone will want to do this again for any other PIIGS.
  • Greece leaves the Eurozone. They’d exchange their Euros for Drachma 2.0′s .  I give this a 50% chance.  This option involves :
    • the most pain on behalf of Greece’s creditors (the rest of Europe).
    • The least pain for Greeks. Therefore the most likely.
    • Large euro-banks taking large losses on their Greek sovereign Bond investments. This in turn weakens the balance sheets of banks and increases the chances of an international banking melt-down.
    • Greece will volunteer to leave the Eurozone because in order for the IMF to make loans to Greece, they’ll want to do what they always do: devalue the currency of the bailout country.
    • Greece can’t do that if it remains in the Eurozone since it cannot devalue the Euro. It will have to exchange its Euros for Drachmas, devalue the drachma 2.0 and repay creditors with devalued drachmas.
  • The EU may form an IMF for Europe – an EMF. But that will take years to put in place. The EU probably does need their own EMF. But since it will take years and not solve the problem at hand, who cares. I’m not even handicapping this event.
  • Germany leaves the Eurozone but remains in the EU (like Britain).  1 in 100 chance. Germany needs the rest of the Eurozone to export its goods and they know this. Germany has it pretty sweet if you think about it. They’re surrounded in countries that are not as manically driven to be efficient and that are unwilling to impose wholesale reductions in the standard of living as they are. In other words they’ve got easy competition and know their businesses will continue to prosper as a result of staying in the Eurozone. Plus Germans have had a decade of steadily lowered pay. They’ve made sustained sacrifices. Juxtapose that to the PIIGS. They’ve had steadily rising wages and standard of living for the past decade.  All of this based on a credit cycle expansion. Germans know that their products compete well in the EU & elsewhere because they’ve made efforts to lower their labor rate to make themselves competitive. So Germany isn’t going to leave the Eurozone anytime soon.
     

    So What:
    • A Greek default alone would be twice the size of the combined 1998 Russian default + 2002 Argentina default. To put that into an investor’s perspective, the S&P500 lost 18% in about a month when the Russian default happened. Interestingly enough, the S&P went from 1186 to 973. 1186 is close / slightly higher than where the S&P is now.
    • A Greek default would cause any assets priced in Euros to tank, and any assets priced in US dollars (and likely other stable currencies) to rise.  The exceptions would be risky US assets like junk bonds and growth stocks of all sizes.
    • A Greek default would likely cause intermediate and long term Treasury ETFs to rise in price considerably over weeks and months — then fall just as much as investors realize the end of the world is not imminent. Another tactical opportunity to wring some returns out of risky short term plays. I have identified a widely traded ETF that holds intermediate Treasuries, and another than is short long-term Treasuries. (For future consideration.) Liquidity is key.
    • If a default occurs, there may be an opportunity to earn a short term return by investing in an ETF that moves with the price of the US dollar (one such ETF has been identified).  But this will be playing with fire because over the longer term, look for all measures to be brought to bare to devalue the dollar. Its a race to the bottom.
    • The price of gold will see massive volatility. On the one hand, we’ll have a flight to safety that causes many to buy gold. There will be another group running to treasuries and any hard asset priced in US dollars. With a flight to dollars, we’ll see all commodities lose value. Of course, that’s true until its not: if sufficient fear builds regarding sovereign debt, even Treasuries will come under selling pressure in favor of gold. Under this scenario, gold could double in price in weeks/months.
    Buckle up. The fun begins now.