I was speaking with a well-heeled colleague of mine regarding all the concern and media attention that Greece has been attracting. He pointed out that, until three months ago, for 99% of investors, "Greece was a bad movie with John Travolta... but now, the struggles of the Hellenes are all anyone will talk about." He went on to add: "Frankly, who cares if Greece goes bust? It's less than 2% of the European economy and 0% of everybody I know's portfolio; the market will be rocky for two weeks and then adjust to the reality that you should be more careful as to who you lend money to!"His comments are very true of course, and my team and I have argued that, with a complete lack of leverage in the financial markets, the contagion effects of a Club Med crisis might not be the multiple of Lehman that so many expect. Nevertheless, the Greek crisis is important because of what it highlights. Specifically:
*The Greek crisis is not at its core a problem of excessive debt. Instead, debt is only a symptom of a wider problem which is that the labor force in Southern Europe is now massively uncompetitive with the labor force in Northern Europe, most specifically in Germany and Holland. And to paper over this widening productivity chasm, government have been accumulating budget deficits for far too long. Unfortunately, to make countries like Greece competitive in a system where Greece cannot devalue against Germany, one needs to see either massive salary cuts similar to what Hong Kong experienced between 1997 and 2003, or a plunge in the Euro which will make Greece competitive if not against Germany, at least against the rest of the the world. (I.e. the Euro gets to be so cheap that the Germans spend their holidays in Corfu instead of Phuket).
*The fiscal tightening the EMU governments will have to endure ensures that the ECB will have to remain very accomodative for as far as the eye can see. In turn, this means that the Euro and long-dated bond yield in countries like Germany, Holland and Scandinavia will continue to fall.
*This last point is the most important. One of the reasons we have been so bullish on China over the years is the pain the country took in the 1995-2002 restructuring of its economy. Over that period, Chinese state-owned industries shed 50 million jobs, and productivity in China went through the roof. This allowed the RMB to move from being overvalued in 2000 to undervalued by 2003. And thus, when the Fed decided to follow an inordinately easy monetary policy which hit the USD (and thus the RMB), Chinese equities and property prices soared. With that in mind, the question today has to be whether Northern Europe is set to go through a similar experience? Indeed, following the past decade's productivity efforts, countries like Germany are already tremendously competitive. So very low interest rates and a lower Euro may not be exactly what Germany, Holland or Scandinavia need. But that is what they are going to get anyway. Leaving us with the question of whether the next property bubble might not take place in Berlin, Hamburg, Warsaw and Bratislava?
Comments courtesy of our team and GaveKal's "Checking the Boxes' - 03/19/10
