Saving Greece’s Sinking Ship

Followers of the financial markets remember what happened to Lehman Brothers during the two weeks leading up to its collapse and sub sequential shock to the global economy. The question is: has the world learned lessons on how to handle this type of crisis?

It seems that in our current market place we are divided into two teams – winners and losers. But instead of competition being held on a balanced playing field, where skill and position decide the outcome of the game, we have a game that is more like American Gladiators, where one team is made up of contestants and the other team is made up of gladiators. Gladiators do not compete against competitors, but instead act as blockers or impediments designed to stop competitors from achieving any type of goal. The American Gladiator arena is basically how the market for Credit Default Swaps (CDS) has been operating. The buyers of CDS, specifically buyers who don’t own the underlying security, are trying to be blockers of Greece achieving its goal of stabilization, as they stand to make a significant winning if Greece is unable to recover and subsequently defaults.

A default by one Euro country could be disastrous for all European countries and this is because of contagion. Contagion is ultimately what led to the currency crisis during the 1990s in emerging economies. The effect on the market occurs because investors begin to treat securities that are similar as identical comparisons, which leads to major sell-offs in indices and underlying securities that are related to the original security. If Greece defaults, investors will look to withdraw from the rest of Europe’s PIIGS (Portugal, Italy, Ireland, Greece and Spain) because they will view these countries as equally susceptible to the risk of default. As a result, the European Union economic zone would risk collapse as after time investors will start to pull away from stronger countries within the European Union. The best recent example of this is what happened to Goldman Sachs during 2008. Goldman Sachs was never at risk of collapsing and they are (and were arguably) the most stable bank within the financial institutions industry and yet their risk of default increased and their stock began to fall simply because weaker financial institutions were beginning to default. Europe has an obligation to itself to rescue Greece and put it on the right track to stability, as it risks its own demise if Greece fails. The European Union, International Monetary Fund and European Central Bank are expected to save Greece if their government makes difficult, but appropriate budgetary choices. If they succeed in staving off a collapse then Europe will be stronger for having done so, as the world would’ve just watched a coordinated effort across the continent to address real concerns, something that many would argue Europe has not done since the birth of the European Union.

The Euro currency has so far been the only real victim in this Greek drama, as it has fallen 3% over the past month. Gyrations in currencies often bring positive effects and negative ones. A falling Euro is good for the European export market as it makes their goods more competitive around the globe, however it is generally bad for the European import and consumer market as cheap discretionary goods become more expensive. The area where this could cause the largest dent to the European consumer is that of energy costs. A significant portion of the natural gas that Europe consumes comes from Russia and the already high fuel prices in Europe could increase further as a result of a weaker currency.

The US has experienced a weakening currency over the last 8 years, which has led to higher energy prices in the domestic market, but it has also benefitted our recovery, as US exports are very competitive in the global market. The relative strengthening that the US dollar has been experiencing is because of a greater global uncertainty (on a relative basis) in other developed countries. If the Greek crisis has shown anything at all from a US perspective, it’s that the US treasury market is still very robust and is considered to be the safe currency. But in saying that, we must remain cautious because if Europe cannot contain the Greek crisis, which ends up causing the Europe crisis, we must be wary that the sentiment does not spread to the US. If there are signs of a collapse, leap into the stable investments such as gold and US treasuries to protect yourself from what could be called the double dip.

This entry was posted on Friday, March 5th, 2010 at 9:58 pm and is filed under EU Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.