Lehman On My Mind

The US government still has not reached an agreement on raising the debt ceiling, the markets turn their backs on Spain and Italy, stocks worldwide erase all their recent month's earnings in two days, gold is near its historic high again... Everybody seems to be expecting another big hit to the economy sooner rather than later. We have already been there, we should know what to do. Quoting the great Ray Charles "No peace I find, just this old sweet song keeps Georgia on my mind". In this case the name may not be Georgia but Lehman Brothers, and the 'song' may not be sweet at all, but we should have it on our minds...

Because while preparing for this kind of impact, what people are not figuring out is that they are inadvertently paving the way for said impact to be much stronger. Nobody seems to trust anybody else these days, and this is bad, very bad for market stability. No matter how long you have traded or invested with a counter-party, no matter how strong and risk-averse you have been for years; in the eyes of others nobody seems safe against what is coming. 

Lehman Brothers' situation was really bad, but it was the mistrust from its clients, partners and rivals that put it into a corner and accelerated its demise. This mistrust seems to be the general rule in financial markets these days. Today everybody is hedging against everybody else, buying insurance and taking CDSs (Credit Default Swaps) through the roof. This mistrust has enough power to stall the global financial markets; and as we recently became aware of, a financial crisis can transform in a fully fledged economic crisis in the blink of an eye. If that was to happen we would find ourselves in the much feared double-dip recession. I do not want to even think about what another economic crisis would mean globally when we are still struggling to make our ways out of the first one. However there is something I can be totally sure of: if such a double-dip recession happened, a lot of players would be out of the game very soon. A lot of companies, and most importantly some countries, would be unable to dodge a second punch when they are still dizzy from the first one.

A skyrocketing euro for a deep diving Europe

Although it is not the first time I write about why I think the actual exchange rate of the euro against other currencies is wrong (see here and here), the latest developments on the Eurozone's life well deserve a revision of the subject. A quick look at the Eurozone lets one see some not very encouraging facts. The Greek tragedy has been quieted down in the last days but is far from over. In fact almost everybody with eyes in the matter is expecting a default sooner rather than later. The only uncertainty seems to rest in knowing if it would be an orderly default, basically a giant debt restructuring effort (hopefully...), or a messy one.

On the opposite side of Europe we have Portugal, but it seems to be in the opposite side only geographically speaking, because its bonds have also been kicked out of investment grade and are now officially  'junk' grade like Greece's. This will make Portugal financing efforts (even) more difficult, which in turn could end with Portugal asking Europe for more money soon. And to complete the domino effect, this troubles are putting extra pressure into Italy's and Spain's not-exactly-buoyant finances.

Credit: Yahoo! Finance

But the euro simply does not care. As seen in the graph above, the euro is rising against the US Dollar, the British Pound and the Chinese Renminbi, and it is doing so with a specially notable rally in the actual week despite all the bad news surrounding the Eurozone. The european currency is spiking also against special cases like the Japanese Yen and the Swiss Franc, although this is a totally different matter. The Yen has its own set of playing rules because of the Fukushima incident, and the Swiss Franc had been overtly growing uncomfortable with its strength against the euro affecting their exports competitiveness. The case with China's Renminbi is a difficult one to analyze, but what happens with the Dollar and the Sterling Pound?

When rescue packages are not enough, a Greek tragedy in the making.

The astonishingly beautiful deep blue waters of the Aegean sea must be starting to boil as of now, with the economic situation in Greece heating up even further. Debt-to-GDP ratio has reached 143%, Credit Default Swaps are at 1371 basis points, S&P downgraded (once more) Greek debt to B rating from BB-, taking it only two steps about the C rating, which effectively erases one from financing and flags you as someone waiting to default. To make matters worse, often-violent demonstrations are stopping the country's already ailing economy day after day. I truly can understand the frustration the situation causes, but halting economic activity is clearly the worst thing to do in the actual situation...

Another rescue package, combined from both the European Union and the IMF (with or without Dominique Strauss-Kahn), seems to be in the way but its effectiveness is already in doubt. A recent poll shows almost everybody thinks this would be artificial life support for Greek debt. Sooner or later a default or a painful debt restructuring process seems to be coming. Not being a debt restructuring expert, just based in common sense I can only say: make it sooner rather than later.

Extending this situation is bad for everybody, it is bad for Greece's future, bad for Portugal and Ireland debt prices and bad for the whole euro area's stability. Stop being stuck in the actual situation, a situation that slowly built the hole where you are now. Just change everything! 

First thing, go out and make the people understand why spending cuts and privatizations are basic, unavoidable and necessary to have a future. You can not afford to have your people burning policemen, destroying everything that comes close and shutting down air transport... Tourism is a keystone in Greece's actual economy, so flying stones and burnt buses are not the best of promotions for the country. In fact any company thinking of investing in Greece as of now would be held back but the situation on the streets.