Wednesday, April 28, 2010

Commodities say forget Greece

I last featured industrial commodity prices a month ago, and I note that they have since risen some 3-5%. Both of these charts reflect prices of a variety of industrial commodities, many of which do not have futures contracts associated with them and are therefore at least somewhat immune from speculative forces.

Commodities across the board are marching onward and upward, apparently oblivious to Greek indebtedness, concerns about which have been plaguing markets for months. In the end, global growth—as is strongly reflected in the commodities markets—is one sure-fire way of dealing with whatever fallout there may be from what will either be a bailout of Greece or a restructuring of its debt. To put things in context, Greek GDP is about $340 billion, which is about what the U.S. government is borrowing every three months. Fears of a default on Greek debt, which is somewhat larger than its GDP, have erased more than $1 trillion of global equity market capitalization, but Greece's total indebtedness, even when combined with other PIGS, is a small fraction of the global bond market. Keep your eye on the big things, like strong global growth and accommodative monetary policies, since those are likely to overwhelm the Greek debt situation.


John said...


I agree that Greece alone can't sink the global economy. But the inability of the other Euro members to address the Greek problems in a timely manner is causing problems in other countries. Portugal looks to be next on the list with Spain looming.

Another troubling thing about Europe is their banks are in worse shape that ours. Most of the sovereign debt is held by the banks. Depositors are withdrawing their money in increasing amounts as the problems continue to go unaddressed. The banks thus are even more dependent on the ECB for liquidity. Unlike here in the US most of Europe's economy is financed through the banks (our bond and equity markets are more sophisticated). With Europe's banks losing deposits and their sovereign bondholdings losing value their ability to finance commerce is suffering, threatening the Eurozone's growth rate. The uncertainty of how this is going to play out is causing nervousness in all the world markets.

The ECB still has their nuclear option: monetize the debt via open market bond purchases. For the inflation fearing Central Bankers this is a nightmare. It also holds enourmous moral hazards (it takes the pressure for fiscal disipline off the guilty parties). Thus it will probably not be used except as a last gasp resort to save a crumbling economy.

The German public is said to be 70% opposed to a Greek bailout. The problem is if they don't, they face the problem of having to bail out their banks since they will be eating the lion's share of the losses. The French banks are particularly exposed. Also, if the Greek debt is restructured, they STILL are going to need assistance because they are still going to need to borrow. What will their rates be when you have just forced their bondholders to eat big losses? And after THAT, how is the bond market going to feel about Portugal's debt? Or Italy's? Or Spain's? I think that after a Greek bond restructuring Every Euro member with questionable fiscal policies faces a big increase in their cost of money, and with virtually no economic growth Europe faces a bleak outlook.

Now despite all this, I still agree with Scott that it really does not seriously affect the US...yet. IF it gets really really REALLY bad it can. But we're still a long way from that. In my memory Europe has never been a big growth engine for the global economy. It has always been the US that was the biggest factor. And now, Asia is playing a larger role than in the past. This crisis in Europe will help the US to the extent that European money flows into our bond markets and supports the dollar. It is, has, and will continue to, IMO. The EU's troubles are going to take awhile to fix.

Thus at the end of the day, it is a good reason for extended equity markets in the US and Asia to make their corrections. It is a normal and healthy process that will serve to extend the rally. Europe's problems are Europe's and not necessarily ours. Watch OUR Fed. As long as they stay accomodative the markets will recover - asia will follow us. We have a little longer to go in this correction IMO so have your buy lists made if you are interested. The market IMO will be much higher at yearend.

John said...

I have just read that Moodys and Fitch STILL have Spain a AAA credit. Amazing. Just amazing.

Bill said...


Is there also a concern that the Greek debt is tied to Credit Default Swaps and the potential amounts owed on the Swaps is greater than the amount of the debt, like the AIG problem?

John said...


Just FWIW I have not seen that concern expressed. Sure doesn't mean it isn't possible. The banks own many of the bonds and a restructuring would impact their capital ratios negatively. But in the end it msy be cheaper to bail out the banks than the countries.

A bailout of the countries would involve a huge moral hazard in that EU members such as Romania would see something similar in their future and would lose fiscal discipline.

There is a case for letting Greece restructure and perhaps exiting the EU, reintroducing the drachma and inflating their way out. That sends the message to Portugal, and others to either get their acts together or get out. It is the basis behind those who think the Euro is a failed experiment.

We will see.

Scott Grannis said...

Bill: the CDS market has for a long time learned how to deal with a notional amount of swaps that greatly exceeds the value of the underlying bonds. This is not a problem at all. With credit default swaps, as with other derivatives, there must be a long for every short, and a loser for every winner, and every person in a losing position must set aside collateral to meet his obligations. There are very elaborate procedures that have been created over the years to ensure everything works as it's supposed to.

Benjamin Cole said...

Paper pulp prices up eight percent since Feb. Demand from Far East, as with so many commodities, is pulling up prices.
Indeed, paper pulp near all-time highs. The Chinese read newspapers.
The Big Q: Will 1.5 billion Chinese buy more and more magazine and newspaper, or migrate to the web, stifling paper demand in the cradle, so to speak?
The same thing may happen with oil and cars. They are working on battery cars and plug-in hybrids.
Before most Chinese enter the middle-class, the government may have mandated battery cars.
Interesting times.

Unknown said...

A few arguments pro bull mkt.
1.Strong US data
2.M&A driven earnings growth
3.Low leverage in the system->low contagion risk (Reuters says he lost a few big banks but instead it opened a thousand accounts for investment boutiques)
4.Bonds flow from weak countries to strong ones supports valuations, via lower discount rate.

Anonymous said...

News from Greece. There´s a bank run - very serious situation, lot of police in front of all banks - I think 2 day left and Greece banks are running out of cash.

John said...


This has been going on awhile and from what you say it looks like its turning into a panic.

Bank holiday coming.

Anonymous said...

@ John - you know a lot about Europe an you are right. Congrat´s.
Just a short video clip from Greece - if Scott agrees. It´s in front of the Ministy of Finance. (20 sec ad)

John said...

Another day of 'nothing' from the EU powers-that-be regarding their financial forest fire that seems to be about as out of control as BP's GOM disaster.

I am continuing to have a bad feeling about this. I am wondering if the EU even has the tools to combat this. More credit downgrades are likely coming for Portugal and Spain as the EU's credibility in the world's bond markets deteriorates.

Hopefully a decision of some kind will come soon.

Charles said...

Americans can certainly forget Greece. Greece cannot pay its debts. Therefore Greece will not pay its debts. The issue for Europe is who gets left holding the bag. If Greece defaults, it appears that French and German banks will be hit hard. Their governments may have to bail them out to some extent. Suppose the EU and the IMF bail out Greece. This will just postpone the day of reckoning for the Greeks and shift the losses around. Does anyone really think the Greeks will get their house in order more quickly if they are bailed out? The German man in the street is right, no bailout for Greece and maybe a bailout for German banks if this is in the national interest.

As far as Spain, Portugal, Italy and Ireland are concerned, they may or may not be able to pay their debts. But bailing out Greece won't change their fiscal reality.

Ultimately, the issue for the Germans is whether they will choose to chain their economy to the least responsible members of the EU and sink as the others go down.

Who cares if the Greeks abandon the euro? Why should the Germans care? Why should American investors care? This will be an issue for the Greeks to settle when Europe stops pandering to their irresponsibility to preserve the illusion of a single European economy.

John said...


Boy are we ever thinking alike here. As I write this it appears there is a deal (finally!) on a bailout package for Greece that includes a wage cramdown and tax hikes. This is going to hurt and I am not convinced the coddeled Greeks are going to take it. As a democracy they have a choice of remaining inside the Euro straitjacket or bringing back their old currency and exiting the union. Which do you think they will choose? The next time they go to the polls we will see but if I had to bet I would say they vote to get out and it won't be close. Nobody there is happy and to me that means this government won't survive. I just don't see the Greek people taking three to five years of financial pain.

The Germans are equally unhappy with having to bail out the undisciplined and dishonest Greeks. In their eyes, they've been used. Also a democracy, why not bring back the DMark, bail out their own banks if necessary rather than pour money down the Greek rathole? If I were running against the current government in the next election those are some winning points in my humble opinion.

I fear the current 'deal' is nothing but a bandaid and the proverbial can is being kicked down the road. Greece looks more and more like Argentina in 2001 when they took the IMF money and then refused to cut their spending. The most probable outcome to me is the Greeks will ultimately make the same decision. And the Germans will say good riddance.

The USA IMO is someday going to lose the confidence of the world's investors if the current trend of deficit spending is not changed. There is an enormous well of confidence in America but it can be squandered. The Federal government must find some discipline soon or we risk a fiscal crisis that will send our interest rate much much higher. Fortunately I do not think we are close but NOBODY knows where the tipping point is.