Excerpted from the latest letter to clients by IceCap Asset Management
Someone has a problem
- When you owe someone $340, it is YOUR problem.
- When you owe someone $340 BILLION, it is THEIR problem.
As of today, Greeks everywhere – all 11 million of them, owe the rest of Europe $340 billion. Considering that over half of this debt was forced upon them by Germany and the IMF, and also considering that their economy is -25% less than it was 5 years ago, and not forgetting that Brussels controls all Greek tax rates, pensions and government spending, it’s very clear that the $340 billion is Europe’s problem.
And if this isn’t enough to worry Germany, one should also know that as of January 25, 2015 – there is a new sheriff in town, they are called Syriza and they were elected by the same 11 million Greeks with the mandate to change the terms of the $340 billion debt owed to Europe.
Ever since Greece revealed in 2009 that with help from Goldman Sachs, it had been fudging its wealth, taxes and debt numbers for over 10 years, Europe stepped in and called the shots. The reason for this fond concern for Greece wasn’t due to Germany’s fondness for sun, sand and ouzo, but rather it was due to Germany’s concern that if Greece defaulted on its debt, then German and European banks everywhere would tumble like a fig into the Aegean Sea.
Since then, the entire European charade of countless bailout funds, countless austerity decrees, and countless threats of economic doom have all been structured to keep the European banking system together. In its current state, Greece has debt that will never be repaid. It will literally take several generations to repay the loans forced upon them. And this is assuming the country can miraculously start running budget surpluses and then avoiding the temptation to spend the surpluses.
The situation between the Greeks and Brussels is fluid and is changing by the hour. While we fully expect Greece to leave the Eurozone, we have no idea when it will occur. In fact, we’re pretty sure Brussels, and not Greece, will blink and offer up some kind of debt extension. After all, at this point it is Europe that has everything to lose and not Greece. Europe’s fear is that if Greece leaves the Eurozone, the seal will have been broken and no one knows what the reaction will be in Italy, Spain, Portugal, Ireland and France. Bank runs are a real possibility, and so too will be the 1000s of protesters in the local squares – clearly not an ideal situation for politicians who want to be re-elected. In short it can get really messy, really quickly. And that’s just the short-term fear. The long-term fear is one where Greece leaves the Eurozone, suffers greatly for a year or two, but then suddenly returns to prosperity.
Either way, the gig is up. The most important point to understand about Europe is that any change that occurs is a result of the people standing up to the current status quo. The situation is extremely interesting. We’ve discussed it inside and out and suddenly financial markets are moving in the direction which we expected to occur. And should the debt crisis in Europe escalate further, we expect the investment world to be turned upside down. Those investments that are considered safe will be risky, and those that are considered risky will be safe.
What goes up can also come down
Whether unknowingly or not, the media and the investment industry has created an information gap wedging the 2008 debt crisis with today’s debt crisis. Chart 4 (next page) shows the difference in debt outstanding from 2008 compared to today. The Public Sector consists of government and tax payers, while the Private Sector is made up of individuals and companies.
Notice the enormous gap that has developed between the two groups over the last 6 years. This is the part that isn’t talked about by the big banks, fund companies and advisors with their clients. The debt crisis was never really resolved. Instead, governments decided to simply transfer the debt problem from the private sector to the public sector.
This is important as it is one of the key reasons for the current crisis.
As a result, capital markets were never allowed to reset. Instead, our governments and central banks have created a financial environment where traditional savers receive little to no interest on their cash deposits, and an economic environment whereby sophisticated investors are slowly withdrawing investment.
This combination is creating deflationary trends around the world, and it is causing the Velocity of Money to plummet. Ironically, this central-bank induced economic combination, is causing central banks and governments to do even more of the same. Insanity at its best.
At some point very soon, this financial-spin-top will lose a few riders and the key one to watch is the government bond sector. Chart 5 illustrates the size and difference between the bubbles in our all too recent past. And as they say in California – the next one will be a big one.
As the bubble in government bonds blows higher and higher, the following investment groups will become considerably risky:
- Government bonds
- Bank & insurance stocks
- Pension funds
- Target Date Mutual Funds
Practically every investor in the world has exposure to the bond market, as well as bank and insurance stocks. Some investors have little exposure while others have a lot of their eggs in this seemingly low-risk basket.
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