Greece is more important than QE

Outlook:

The US releases the “advance” version of Q4 GDP this morning, expected to come in at 3.1-3.2%. This is one of those cases where an on-target number or a better number does not help the dollar, while a worse-than-forecast number is dollar-negative. The real meaning of an on-target number is that the Fed already has this information and it’s baked into the statement that we will not get a rate change for the next two meetings but we can again start imagining June. (Or not. There might be more negatives coming and the First Rate Hike can easily be postponed to a later date,even Q1 2016, as Morgan Stanley predicts.)

It is this degree of uncertainty that may be behind the US stock market whipsawing this week. The FT notes that the S&P has moved by an average 1% in the last four days, “with some sharp intraday reversals challenging traders’ nerves…. Risk appetite took a whack after the market inferred the Fed’s statement was less dovish than hoped.”

Another problem is oil. It keeps bouncing off lows in the low $40’s and hope springs that a bottom is in, but then we get comments like Goldman’s this week that the price is headed for $30.

Investors and traders are worried about Greece and Grexit, even though it’s early days. The press has scare stories. The WSJ has a headline today “Why the Eurozone May Need to Sacrifice Greece to Save Spain.” The story positons the new Greek leadership as pinkos demanding a bigger handout, whereas Spain is getting a turnaround on pro-market reforms. “Madrid believes that it would be in Spain’s and the eurozone’s best interests to allow Greece to crash out of the eurozone rather than boost support for Podemos and risk the recovery, according to someone familiar with its thinking.”

Let’s point out, first of all, that governments don’t think. Individual officials think. So this point of view is from an unattributed source. Secondly, the bailout is not a handout to Greek citizens for beer and pizza but goes mostly to creditors.

Third, Spain’s Podemos party is an ideologically muddled bunch of disorganized students and old-timey leftists, according to The Guardian. Its main goal is ending “traditional politics and rolling back austerity. Its key target is la casta (‘the caste’), the dominant two-party system that has ruled Spain since democracy was restored in the late 1970s, after Franco’s death.” The actual Socialist party in Spain has more power. The probability of Podemos getting more than the 8% it got in the last election is remote, if only because they can manage a street demonstration but they can’t run an office. Democracy allows for fringe points of view. Okay, the fringe Tea Party in the US got more power faster than anyone expected, but partly (or mostly) because it de-emphasized smaller government and deficits to yell about social issues (gay marriage, etc.).

We think that Greece is more important than QE. It’s a battle between the property rights of creditors—to an investor, a Greek bond is “property”—and the right of people to be governed fairly and in their best interests. It’s not in the best interests of a people to borrow madly and then default. The cost of later borrowing goes up and stays up, while reputation goes down the drain. Historically, Greece is one of the big defaulters (along with Spain, which wins the prize, according to Rogoff and Rinehart).

All the same, nearly all of the bailout money has gone to repaying old debt and hardly any of it goes to subsidizing citizens. Economist Krugman may be annoying, but he’s factually correct when he says “… you can think of European policy as involving a bailout, not of Greece, but of creditor-country banks, with the Greek government simply acting as the middleman — and with the Greek public, which has seen a catastrophic fall in living standards, required to make further sacrifices so that it, too, can contribute funds to that bailout.”

The Germans are wrong to position the bailout as subsidizing lazy moochers, what Krugman calls the “moralizing myth,” and the Greeks are wrong to position the bailout as nothing but unfair to the Greek people. It was those people who elected the previous governments that got them into this fiscal mess in the first place. Responsibility lies with them. So it’s a battle between the financial contract that prioritizes the property rights of the investors and the social contract between the people and government. Ah, and therein lies the rub. Which government—the Greek government or the eurozone “government” that in this case is unelected and consists of the ECB and the Eurogroup. This is why, we imagine, Dijsselbloem hurried to Athens before the week was out.

We can see no other path for the euro than down, breaking support and targeting the last low at 1.1097 from Sunday.