How Greece Plays Out

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Greece at the birth of Western civilization is now the beginning of the end
By Gijsbert Groenewegen

Goldman trading against its clients interests

The latest in the saga of Goldman Sachs "too close sailing to the wind" is characteristic of the times we are living in. The structure of our society is undermining itself propelled by greed. This is the beginning of the end of an era. When do people wake up to the arrogance of Goldman Sachs? "Helping" Greece structure financial transactions so that they would qualify for entry in the EU (how ethical is that) whilst at the same time probably taking out CDS on Greek debt. Getting 100% on AIG’s obligations, why!? What was discussed in the telephone calls between treasurer Paulson and Blankfein? See their telephone records how many telephone calls were made. Stephen Friedman, then chairman of the Fed, bought Goldman shares (Dec 17, 2008) because he knew the system was going to be rescued peaking to his pals at Goldman and the Treasury. Setting up a "portfolio to fail" and then actively selling it to its "clients" knowing very well how dire situation in the CDO and mortgage markets was. Resetting the terms of last year’s Lloyd’s Bank bonds’ issue Goldman was typified as dictatorial! This bank is as unethical as they come with the sole purpose of making money at anybody’s expense even their own clients. They lie by omission by not disclosing all of the facts and they don’t know the meaning of fiduciary trust. Who sells crap to its clients? Goldman also published private emails of "their employee" Tourre whilst they were never requested by the Senate commission. Why? Who makes money on trades and then hangs its own employee out to dry? They never know when enough is enough. What has made them successful will be their downfall.

After the hearings Goldman announced that they were going to revise their practices; clearly the intention to conclude a deal with the SEC. Still their PR fall-out and credibility will take a long time to restore itself if at all.

Postponement of Execution for Greece and the Euro Zone?

Greece 2009 deficit of Euro 32.3bn was revised from 12.7% of GDP to 13.6% and probably will be in excess of 14%. Who believes the data released by the Greeks anymore after they misled the EU about their finances in order to qualify entry? By the end of 2010 the Government debt is forecast at Euro 294bn or 123% of GDP. Interest rates on the 10-y Government bond soared to 11.2% whilst 2-y bonds were yielding 18.8%. In other words, interest payments were much higher than GDP growth (When Government debt is exceeding GDP it is difficult if not impossible to reverse the situation) and the deficit is widening further as a result if expenditures exceeding income. Some 13% of Government revenues are spent on interest payments which obviously can’t be used for other Government programs. After WWII US Debt to GDP was 120% although the difference then was that people were determined to build the country back up again. We don’t believe that in the current situation, with today’s complacency, greed, intolerance, and lack of common interest and humility, there will be a similar determination and joint effort as after WWII to solve the quickly deteriorating structural state of affairs.

Standard & Poor’s downgraded Greece to "junk" status and Portugal to four notches above junk on April 27. The premium for 10-year Greek government bonds over euro zone benchmark German Bunds blew out to 942 basis points – its highest since late 1996 – from 690 bps April 28. The two-year Greek bond yield briefly hit more than 28 percent earlier in indicative trading. Greece called in the EU and IMF (which funds are mainly paid for by the US) back stop aid because the situation became untenable. Pimco was quoted to be not we repeat not a buyer of Greek debt! About 70% of Greek Government bonds or Euro 213bn are held abroad whilst some Euro 38bn are held by banks in Greece. Over the May first weekend Greece was awarded Euro 110bn over three years of which Euro 80bn will be contributed by the Euro zone countries. Under the plan Greece has to reduce its budget deficit from 13.6% of gross domestic product to below 3% of GDP by 2014 and to stabilize the public debt at about 140 per cent of GDP. The package includes tough measures to reduce the size of Greece’s bloated public sector. Cuts in public sector salaries and pensions, a rise in value-added tax and an increase in fuel, alcohol and tobacco taxes, one out of three workers is a civil servant.

According to an article in the weekend edition of the NY Times in the wealthy, northern suburbs of Athens, where summer temperatures often hit the high 90s, just 324 residents checked the box on their tax returns admitting that they owned pools. So tax investigators studied satellite photos of the area — a sprawling collection of expensive villas tucked behind tall gates — and came back with a decidedly different number: 16,974 pools. When tax authorities surveyed the returns of 150 doctors with offices in the trendy Athens neighborhood of Kolonaki, where Prada and Chanel stores can be found, more than half had claimed an income of less than $40,000. Thirty-four of them claimed less than $13,300, a figure that exempted them from paying any taxes at all. According to the general secretary of the Finance Ministry one needs more than that to pay your rent in that neighborhood. He said there were only a few thousand citizens in this country of 11 million who last year declared an income of more than $132,000. Yet signs of wealth abound. So who in his right mind believes that the Greek will suddenly abandon their past behavior in name of the greater good? In our point of view, nobody, especially also because the tax collection force appears to be quite corrupt. Apparently, of taxes due one third is paid to the state, one third to the tax collector and one third is being kept by the tax payer, if he reveals any due taxes at all!!

We don’t see a way out, although the Euro zone countries, of which many are already in a perilous state, did not have a choice but bail out Greece, hope that there will be no contagion, giving them more time for the economies to recover! Structurally though nothing has changed at all and won’t. Only pain will alter the DNA/make-up of a population forcing them to pay their rightful dues. The Euro zone countries and IMF are throwing good money after bad money, worsening their own situation and only buying postponement of execution for the Greek and other debtor countries. According to an article in the NY Times using BIS information, Greece (total debt $236bn) owes nearly $10 billion to Portuguese banks, and with Portugal (total debt $286bn) being downgraded and facing higher borrowing costs, a default by Greece would worsen Portugal’s situation further. Following the chain, Portugal, in turn, owes $86 billion to banks in Spain (total debt $1.1trn). Remember as we mentioned in our previous article the banks connect all of the problem areas because the banks have a lot of sovereign debt on their books. Ireland (total debt $867bn) in turn is heavily indebted to Germany and Britain. The exposure of German banks to Spanish debt totals $238 billion, according to the Bank for International Settlements, while French banks hold another $220 billion. And Italy (total debt $1.4trn), is owed $31 billion by Spain and owes France $511 billion, or nearly 20 percent of the French gross domestic product. The PIIGS countries owe the French banks and Government $911bn, the German banks and Government $704bn and the British banks and Government $418bn.

Citigroup said Europe’s 24 largest banks must raise €720bn over the next three years, in a world where investors want a higher return for risk. "This could eventually drive up funding costs meaningfully," it said. Next to that we have to look at the average maturity of the sovereign debt of the subsequent countries, and when each amount matures in the next three years. For example, the average debt maturity of the UK sovereign debt is 14 years, compared to 8 years for Greece. The UK is forecast to have a 2009/10 budget deficit of sterling 170bn or 12% of GDP whilst for 2010/11 the budget deficit is forecast at Sterling 156bn. The question is, who will be willing to finance these deficits and has the confidence that these problems will be solved structurally?

Some people are suggesting that a debt reduction is needed to solve the problem. In any case whatever direction is taken the banks will suffer. If Greece goes the European banks and the Euro zone go. The question is how much time Greece and the Euro zone are buying. Looking at the sell-off that started on May 4 not very much.

Are the "strong" earnings sustainable?

Of the S&P 500 companies reporting, 85 percent have beaten analyst’s expectations according to Bloomberg. This compares to 61 percent that has been typical in recent quarters. Even more surprising, 70 percent of these companies beat revenue estimates. However, it indicates that companies are growing the top line as well as the bottom line. The surprise in earnings to the up side makes sense.

During the recession, companies were quick to reduce their expenses (labor costs) when the economy crashed. As the economy recovers, companies have been slow to increase hiring and are controlling other expenditures. As a result, margins remain strong, leading to better earnings than many thought possible. Corporate revenues are also growing as companies find quality sales opportunities mainly from the emerging markets. However, the financial sector is contributing a substantial portion of the growth in revenues as it recovers from the beating they took a year ago. Citi bank announced profits of $4.4bn for the first quarter, although uncertainty over the winding down of the bank’s $500bn portfolio of troubled assets could affect future earnings!! JP Morgan showed first quarter profits of $3.3bn +55% due to lower losses for their credit card and mortgage businesses. It says lower losses! One swallow does not make a summer. We believe this is a cyclical recovery and not a structural recovery because the upturn is too much driven by the hundreds of billions of stimulus and we don’t believe countries have the balance sheet to sustain a recovery.

As a result of the positive results (following very easy comparisons) we have definitely seen a stronger recovery in the market than many of us believed was possible assuming the weak economic fundamentals, although we would like to emphasize that we have arrived at 1200 in the $&P, a 62% retracement since the low in March 2009. The 62% (61.8%) is also an important Fibonacci number and therefore it will be interesting to see what happens from here. The sell off on May 4th might be an indication that the recovery in the stock and other markets is over.

Another point of attention in our point of view is that China’s Shanghai index which closed at 2870 on May 4 at 47% of its high of 6124 whilst the Dow Jones closed at 10,927 trading at 77% its high of 14,164. How come that the number one growth economy in the world with a much better debt situation, and forex reserves of $2.5trn, has a stock exchange index underperforming the benchmark index in the US, while the US has a $1trn deficit and debts in excess of $12trn.

According to a Wall Street Journal article the Commerce Department reported April 30 that private investment in equipment and software, everything from machine tools to word-processing programs, rose at a robust annualized rate of 13.4% in the first quarter of 2010, adjusted for inflation. It was the third straight quarter of growth since the economy hit bottom in mid-2009, but slower than the 19% pace of the previous quarter. Factory orders in March were up 1.3% versus 1.3% the previous month. Think comps and government subsidies, we believe this is the beginning of a declining trend. The subsidy effects and easy comparisons are over!

Business investment overall, including money spent on warehouses and office buildings, grew at an inflation-adjusted annualized rate of 4.1%, dragged down by the persistent slump in commercial real estate. Among the bright spots: Building of mining structures such as natural-gas rigs rose 43.8% which "artificially" boosted the 4.1%. Watch the May housing figures because of the expiration of the tax credits on April 30. In the first quarter of 2010, net private investment—including capital spending on everything from houses to assembly lines, minus depreciation—stood at 1.6% of economic output, well below the 20-year average of 5.4%. Supported by a tax credit, the pending home sales index rose a seasonally adjusted 5.3% in March, versus 8.3% in February. Again we see less robust net private investments and a declining growth rate.

The increased spending on equipment and software encouraged hopes that businesses will help lead the economic recovery, generating enough investment and jobs to sustain a recent resurgence in consumer spending. So far, though, it is falling well short of the pace needed to drive the kind of sharp, "V-shaped" recovery that has followed deep recessions in the past. Again as we mentioned in our previous article we don’t believe the economy will recover because of three factors: housing (residential and commercial), debt levels and unemployment.

In the first four quarters after the harsh recession of 1981-82, inflation-adjusted investment in equipment and software rocketed back at an average annualized rate of 21%, helping to drive nearly 8% growth in the broader economy.

On average, economists expect the U.S. to grow at an inflation-adjusted rate of 3.1% in 2010. Most business surveys show optimism rising and many companies planning to boost capital expenditures further in coming months. But disparities remain. Buffett was quoted on CNBC that he saw business to business activity really improving but consumer driven business was definitely lackluster. Large companies that export to growing Asian economies, for example, tend to be in better shape than smaller firms, many of which still face lackluster sales and problems getting the credit they need to expand.


We believe that the US dollar and the US bonds are likely to strengthen following the problems in the Euro zone. We see the Euro and Pound Sterling going to parity with the US Dollar. The relative weakness of the Euro strengthening the dollar is also likely to strengthen the ultimate currency: gold. Greece is adding fuel to the undermining of the currencies, competitive currency valuations boosting the resources. Don’t forget the currencies are the benchmark of our wealth and if their purchasing power goes, where does one invest? Gold, the ultimate currency that cannot be printed to cover up mistakes made by bankers and politicians and does not have any counter party risk, is gaining popularity amidst other resources. With the state the markets are in, investors should be very aware of purchasing power, bond downgrades and counter party risk!! This is only the beginning.

Jay Taylor
Gold Investor


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