This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Wednesday, May 5, 2010

Greece’s Achilles’ Heel

The financial difficulties facing Greece have been very well documented over the past few months, and until recently it appeared that the powers that be were preparing to bailout the country, which has been plagued with riots.

However, it is now coming to light that the prospects of a bailout are quickly fading, at least in part because such a bailout was contingent on concessions for Greece’s union-organized work force. It seems now that those concessions will not be made, and hence the bailout will not occur.

To show the world just how convoluted a financial situation Europe currently faces, the New York Times recently published a chart constructed by Bill Marsh that displays Europe’s so-called “Web of Debt.”

While this map certainly shows just how confusing the situation has become across the pond, both its architect and its believers are operating under a very danger assumption: that the debt will paid. As we’ve mentioned before, all too often people forget that governments do in fact go broke.

For evidence, just look at Russia, Argentina (twice), the City of New York, and California. Add to that a good deal of near-misses, like in the early ‘90s when Mexico had to devalue the peso in order to keep from going broke. In fact, between the mid ‘80s and the mid ‘90s there was a wave of debt defaults – excuse me: restructurings – among Latin American countries that almost sent Citigroup under.

When it comes to debt, people and corporations have only two options: either pay it off, or default. Since they own the printing presses, governments have the convenient third option of inflating their debt away (paying it off with currency hot off the presses, and subsequently worth less).

Unfortunately for those of us subject to the whims of our governments, even when our fearless leaders DO decide to pay debt off, they very rarely do so responsibly. More often they incorporate their inflation option to some degree.

Why, you may ask, would they do such a thing? The better question is why not. The answer, dear Watson, is that their creditors have no recourse, no way of stopping them. The holders of government debt, when that debt goes sour, have only two options. They can either take what the issuer offers them, or they can walk away.

The basic concept that needs to be understood from all this is that governments do not act ethically or responsibly. They have nothing to do with responsibility, much less intelligence, but with feelings. Elections are predicated on pain, and who has caused the least in voters’ short memories. Therefore, governments choose the path of least resistance – and least pain.

Consider the following: Recently minutes that were released from a 2004 meeting of the Federal Reserve Board of Directors (such minutes are not released for several years after meetings occur) reveal that then-Chairman of the Fed Board Alan Greenspan was actually aware of a possible bubble forming in the real estate sector all the way back in ’04, more than two YEARS before the real estate market crashed!

In fact, that this meeting in 2004, several of his subordinates, including Jack Guynn (then-President of Federal Reserve Bank of Atlanta) and Cathy Minehan (then-President of Federal Reserve Bank of Boston) expressed significant concern about ‘overbuilding’ that was occurring at the time. As history tells us, Greenspan obviously ignored this advice, and allowed the real estate market to continue its trend of increasing-prices and overbuilding. We all see how that turned out.

Mark my words, events in Greece will not play out in totally dissimilar fashion. Remember that this little invention called the Eurozone is little more than a decade-old experiment, in which almost every member country regrets participating. It will come as no surprise to us if the Eurozone collapses in the next five years.

Likewise, the offshore trend that has lasted nearly 20 years is just about to end, and like dot-com and tech stocks before it, investors will soon find that off-shoring is not the wave of the future. After years of investors hearing that they need to be putting money in gold and foreign securities – far away from US dollars – the party is quickly coming to an end; and the last one to leave gets to pay the tab.

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