Mexican Standoff

As we always point out in these pages, the best one can as a rule hope for in a politician is that he will provide us with entertainment. Syriza chief and new Greek prime minister Alexis Tsipras and his ministers have certainly exhibited far greater entertainment value so far than their rather dull predecessors.

Within hours of taking up his post, Alexis Tsipras issued a number of zingers in the general direction of Brussels. First it was widely reported that he threatened not to support new EU sanctions against Russia, the imposition of which requires unanimity. It was then said that the Greek government quickly withdrew its opposition after consulting with the rest of the EU. However, the real story seems to be that Tsipras was simply miffed that the EU claimed that there was unanimous support for the sanctions package without deigning to even ask the new Greek government whether it agreed.

As an aside to this, people have wondered why Russia has offered financial support to Greece; the conclusion is usually that Russia is trying to gain allies in the EU so as to break the sanctions consensus. This is of course true, but there is more to this than meets the eye. Greece and Russia are traditionally on friendly terms because the Orthodox faith is the main religion in both countries. The same connection exists also between Serbia and Russia and it could also be one of the reasons why a number of Russian oligarchs had money parked in Cypriot banks.

The first negotiation gambit has been initiated today, with Greece’s new finance minister Yanis Varoufakis telling the EU’s Jeroen Dijsselbloem (of “bail-in” fame) that the “troika” and its bailout packages are no longer welcome in Greece:

“The new leftwing government in Athens opened negotiations on its bailout package with European partners on Friday by flatly rejecting the expected extension of the program and the international inspectors overseeing it.Finance Minister Yanis Varoufakis met Jeroen Dijsselbloem, head of the euro zone finance ministers’ group, in Athens for what both described as “constructive” discussions on the new government’s aims.But the hour-long meeting appeared to do nothing to bridge the gap between Prime Minister Alexis Tsipras’ government and European partners who have insisted that Greece must respect its obligations under the 240-billion-euro bailout.The meeting with Dijsselbloem was the first in a series for Varoufakis, who travels to London, Paris and Rome next week as the government looks to build support.Tsipras, who makes his first foreign visit as prime minister to Cyprus on Monday, will also be in Rome on Tuesday for meetings with Italian Prime Minister Matteo Renzi, one of the leading voices in Europe against strict budget austerity.But he said Greece had no intention of cooperating with a mission from the “troika” of European and International Monetary Fund lenders and would not be seeking an extension to a Feb. 28 deadline with euro zone lenders.“This platform enabled us to win the confidence of the Greek people,” he told reporters after the meeting. “Our first action as a government will not be to reject the rationale of questioning this program through a request to extend it.”

(emphasis added)

As Mish has recently reported, Alexis Tsipras wrote an open letter to Germany prior to the election, which doesn’t contain a single word one can disagree with. The gist of it is that the EU decided to adopt an “extend and pretend” scheme with Greece that ended up saddling an already insolvent government with even more debt, a truly grotesque situation. Mr. Varoufakis espouses the same viewpoint as Tsipras on the matter, which is essentially: Greece should never have taken the money in the first place, but should have insisted on a proper debt restructuring instead – i.e., the insolvency should have been acknowledged, and unsound debt should have been written off. In his own words:

“Europe in its infinite wisdom decided to deal with this bankruptcy by loading the largest loan in human history on the weakest of shoulders, the Greek taxpayer. What we’ve been having ever since is a kind of fiscal waterboarding that has turned this nation into a debt colony.”

A recent interview of Varoufakis with Channel 4 can be seen here. In this interview he promises to take on the “Greek oligarchy”, but it seems that the government is already backtracking a bit, at least with respect to Greece’s shipping tycoons, who enjoy special tax breaks. This reflects merely economic realities though: Greece can gain nothing by attempting to go after the money of shipping magnates. They can relocate very easily, as their assets are floating on the sea. Their industry produces 7% of Greece’s GDP, so going after them would be tantamount to slaying the goose that lays the golden eggs. Still, it is refreshing to learn that the new government recognizes such economic realities.

Surprisingly, although Varoufakis is these days finance minister in a left-wing government, you can find him talking among other things about Hayek, Mises and the spontaneous order of the market economy at the Library of Economics and Liberty. Vanoufakis once worked for Valve, the video game company that developed “Steam”. Apparently the company applies Hayekian principles in its structure, by eschewing the usual corporate hierarchy.

The problem as we see it is not Syriza’s opposition to the bailout deal –  the problem is that it also proposes economic measures that will destroy the not inconsiderable gains the country has achieved in terms of increasing its competitiveness. Among these measures are plans like rehiring 12,000 civil servants (the Greek State is notoriously inefficient and corrupt, and in dire need of slimming down), abandoning privatizations and raising minimum wages. In fact, the Greek economy does show some signs of life lately and would probably improve greatly if structural reforms were continued.

Mexican Standoff Continues

The problem with the proposed debt negotiations is that the other EU members continue to categorically rule out debt forgiveness. As the deadline of the meeting with the troika that was scheduled for the end of February looms, the question becomes therefore who will blink first. Germany let it be known that it is not amused:

“The discussion about a debt cut or a debt conference is divorced from reality,” Martin Jaeger, a German finance ministry spokesman, said in Berlin. Jaeger said Greece was obliged to abide by the terms of its 240 billion euro ($270 billion) bailout program agreed by previous governments or endanger the deal.Without the rescue loans from its fellow eurozone countries and the International Monetary Fund, Greece would go bankrupt.“If the measures announced by the new government in Athens were implemented, then one has to ask whether the basis of the program wouldn’t be called into question and therefore pointless,” he said.

(emphasis added)

In short, nothing has changed yet in terms of the Mexican standoff we have previously discussed. The main problem from Greece’s perspective is that euro membership could well become impossible if no agreement is reached in time. All that is needed for Greece to be effectively kicked out of the euro area is for the ECB to refuse the granting of ELA (emergency liquidity assistance) to Greek banks. Greece’s national bank could well attempt to extend ELA on its own without permission, which would lead to an interesting situation, to say the least. A Greek government default would immediately bankrupt the country’s banking system – for the second time.

Private holders of Greek securities are definitely spooked. Since Syriza has come to power, three year government bond yields have nearly doubled. Similar to the heyday of the sovereign debt crisis, short term yields are rising much more then long term ones, leaving the yield curve in a steep inversion (10 year yields are  “only” at 11.55%).

Greece’s 3 year government bond yield – bondholders are spooked and selling into what appears to be a no-bid market.

The Athens General Index meanwhile is approaching the lows made in 2012 at the secondary peak of the debt crisis, erasing most of the sizable gains that were recorded between 2012 and early 2014:

Athens General Index, weekly – click to enlarge.

This could well mean that a very good buying opportunity is close at hand, not least because the market is down even more in US dollar terms, thanks to the euro getting mauled on account of the ECB’s ultra-loose monetary policy.

GREK – a US listed ETF that contains the 20 largest Greek stocks by market cap – click to enlarge.

Unfortunately for bottom fishers, there is the problem that if Greece is indeed  pushed out of the euro area, the new currency would likely quickly lose a lot of ground as well. There would probably be a strong rise in stocks in local currency terms, but for foreign investors it may not amount to much. The danger of hyperinflation would likely come into view as well.

Nevertheless, this is precisely the kind of situation that should be of great interest to contrarians. One of the things one can always try given the uncertain outcome is a bet that involves only a very small outlay, such as e.g. buying out of the money call options. In the worst case, one might lose the entire sum invested, but the payoff could be huge if things turn out well. In addition, should push come to shove and Greece be forced to abandon the euro, one can still take another look at Greek assets once the dust has settled.

Conclusion:

So far, Syriza doesn’t disappoint in terms of making the European political landscape a lot more entertaining. In the process, it may actually be creating a few interesting opportunities for alert and adventurous contrarian investors, although some patience is probably still required. Syriza is not a monolithic organization, but it does have a very strong far-left wing, so we remain quite skeptical about its plans with respect to economic policy. Surprises are definitely possible in the realm of politics though, and it happens actually fairly frequently that those who are thought least likely to implement meaningful reform end up doing just that.

Reprinted with permission from Acting Man.