Article

Greek Dramas

April 12, 2010

Markets have enjoyed a good run. Easy money usually works. Central banks in the west have not only wanted to keep their rates down, but have let everyone know they are in no hurry to put them up. The Indian and Chinese authorities have let it be know they are tightening, but not at a pace which terrifies the share buyers. They too have no wish to strangle the recovery.

In the last couple of days one of the negatives that remains unresolved has come back to haunt markets. The Greeks have to borrow large sums of money to keep their public sector afloat. There was no firm conclusion to the talks to arrange special loans. The EU gave out a few warm words, but was not offering any money. The IMF is there as a backup. The big demands of the Greek borrowing programmes, swelled by the need to refinance old debt as well as to finance new borrowing needs, has forced Greek rates up to nearly 8%. Greece is now paying 4.5% or 450 basis points more than Germany to borrow, despite sharing the same currency. If you think the Euro survives and think Greece will continue to pay the interest you should sell German bunds and buy Greek bonds.

People are not doing so because they fear this crisis could get worse before it gets better. The Greek banks are experiencing withdrawals. Greeks are seeking to dump or shift assets and place their money somewhere more stable as they see it. This has some adverse knock impact on the rest of Europe.

The Germans rightly say the answer is for Greece to cut her public spending more. It needs to be cut to the level that markets will accept and finance at sensible interest rates. If the current high rates persist for too long, the position is worsened, as the debt interest costs in turn force up the budget deficit. A heavily indebted country can get into a vicious circle, where debt payments take up more and more of the public budgets and themselves undermine confidence in the state.

There needs to be a further set of discussions, either with the IMF or with the EU, for Greece to arrange back up credit lines and to gain international endorsement of her fiscal strategy. Without that her markets remain vulnerable to runs like the one this week, and her budget position is weakened by the high interest rates.

Meanwhile markets seem to think Greece is on her own, and that the other high borrowing countries are in the clear. Investors should not take this for granted. We have always thought this could be a rolling state debt crisis, where several countries are overstretched and could be vulnerable. We think the Euro will survive, but at a price. Gradually the EU will need to exert more control and budget discipline over its members, and gradually it will have to evolve more easily accessible transfer arrangements for cash, loans and subsidies between states, just as national jurisdictions arrange between the regions within their single currency areas.

In the meantime we continue to run balanced portfolios, and have been pleased with the first quarter returns. This year should see lower returns than 2009 but positive ones. There will be bumps along the way, as the imbalances between west and east and between borrowers and lenders is still very large.

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