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Goldman's "Conspiracy Theory" Stunner: A Greek Default Is Precisely What The ECB Wants
Last week, we showed a curious thesis by Goldman, which asked if there is a new and "ominous" development in European currency swings, namely the emergence of what may be a "under the table" fight between the ECB and the Bundesbank on which bonds to monetize.
This is what Goldman said then:
the average maturity of ECB bond buying is around 8.0 years, in line with what Executive Board member Coeure said in his May 18 speech. However, while Italy and Spain see purchases that have an average maturity above that of the outstanding debt stock, Bundesbank buying has fallen short from the very beginning.... This kind of signal – from the key hawk in the Eurosystem – has the potential to undercut the credibility of ECB QE, since it weakens the portfolio balance channel.
After all, it was supposed to be low yields in core Europe into risk assets. If those yields now rise and become more volatile, such portfolio effects will be lessened.
Today, in a follow up report by Goldman's Robin Brooks and company, and one which seeks to validate Goldman's "top trade" thesis of a weak Euro currency, (recall Goldman top trade #1 for 2015: "Stay long EUR/$ downside via 1-year 1.00/0.95 put spread (originally at 1.20/1.15 with a premium of 70bp EUR at initiation, expiring on 20 Nov 2015, opened at a spot EUR/$ of 1.253 on 20 Nov 2014, currently at 1.135.") Goldman explains why despite relentless Greek drama, the EUR hasn't moved and its conclusion is that this is due to "growing question marks over ECB QE" as a result of the surprising bond-buying on the short end (at the expense of reducing longer-term maturity holdings) out of the Bundesbank which has "reduced the maturity of its QE buying."
From Goldman:
As tensions around Greece have mounted, it is something of a puzzle that EUR/$ has shown little reaction. Our explanation, laid out in our last FX Views, is that much of this price action stems from the Bundesbank, which has reduced the maturity of its QE buying, enabling the Bund sell-off and moving longer-dated rate differentials in favor of the Euro. EUR/$ thus hasn’t traded Greece, but instead growing question marks over ECB QE.
Here is Goldman's full take:
From an economic perspective, Greece shows that “internal devaluation” – whereby structural reforms are meant to restore competitiveness and growth –is difficult politically and a poor substitute for outright devaluation. Emerging markets that devalue during crises quickly return to growth, powered by exports, while Greek GDP continues to languish. We emphasize this because – even if a compromise involving a debt haircut is found – this will not do much to return Greece to growth. Only a managed devaluation, with the help of the creditors, can do that. With respect to EUR/$, we think the Bund sell-off increases EUR/$ downside if tensions over Greece escalate further. This is because the ECB, including via the Bundesbank, would almost surely step up QE to prevent contagion. We estimate that the immediate aftermath of a default could see EUR/$ fall three big figures. The ensuing acceleration in QE would then take EUR/$ down another seven big figures in subsequent weeks. We thus see Greece as a catalyst for EUR/$ to go near parity, via stepped up QE that moves rate differentials against the single currency.
Incidentally, "internal devaluation" is a very polite way of saying plunging wages, labor costs, and generally benefits, including pensions.
But if this is correct, Goldman essentially says that it is in the ECB's, and Europe's, best interest to have a Greek default - and with limited contagion at that - one which finally does impact the EUR lower, and resumes the "benign" glideslope of the EURUSD exchange rate toward parity, a rate which recall reached as low as 1.05 several months ago before rebounding to its current level of 1.14. Needless to say, that is a "conspiracy theory" that could make even the biggest "tin foil" blogs blush.
A different way of saying what Goldman just hinted at: "Greece must be destroyed, so it (and the Eurozone) can be saved (with even more QE)."
Or, in the parlance of Rahm Emanuel's times, "Let no Greek default crisis go to QE wastel."
Goldman continues:
Greece, like many emerging markets before it, is suffering a balance of payments crisis, whereby a “sudden stop” in foreign capital inflows caused GDP to fall sharply. In emerging markets, this comes with a large upfront currency devaluation – on average around 30 percent across nine key episodes (Exhibit 1) – that lasts for over four years. This devaluation boosts exports, so that – as unpleasant as this phase of the crisis is – activity rebounds quickly and GDP is significantly above pre-crisis levels five years on (Exhibit 2). In Greece, although unit labor costs have fallen significantly, price competitiveness has improved much less, with the real effective exchange rate down only ten percent (with much of that drop only coming recently). This shows that the process of “internal devaluation” is difficult and, unfortunately, a poor substitute for outright devaluation. The reason we emphasize this is because, even if a compromise is found that includes a debt write-down (as the Greek government is pushing for), this will do little to return Greece to growth. Only a managed devaluation can do that, one where the creditors continue to lend and help manage the transition.
Here, Goldman does something shocking - it tells the truth! "As such, the current stand-off is about something much deeper than the next disbursement. It signals that the concept of “internal devaluation” is deeply troubled."
Bingo - because what Goldman just said in a very polite way, is that a monetary union in which one of the nations is as far behind as Greece is, and recall just how far behind Greece is relative to IMF GDP estimates imposed during the prior two bailouts...
... simply does not work, and for the union to be viable, a stressor needs to emerge so that broad currency devaluation benefits not only the peak performers, i.e., the northern European states, but the weakest links such as Greece.
Incidentally, all of this was previewed long ago in, in December 2012 when we wrote "Next Up For A "Recovering" Europe: A 30-50% Collapse In Wages In Spain, Italy And... France." To Greece's great chagrin, all of this internal devaluation has mostly impacted the impoverished country, which continues to be a shock absorber to broader internal devaluation across the entire Eurozone.
Which brings us back to Goldman's assessment of the current Greek state, and the suggestion that all the smoke and mirrors flooding the headline-scanning algos is nothing but noise, and that in reality the forces are alligned to "push the EUR near parity in fairly short order."
Paradoxically, Goldman keeps pushing for a worst-case outcome, and one where the market finally reprices all the risk it has ignored for months:
Even if Greece ultimately stays in the Euro (our base case), the immediate aftermath of such a non-payment will be to push bond yields up across the periphery. This rise in the fiscal risk premium (Exhibit 3) will of course be limited, because the ECB will likely accelerate QE, including via the Bundesbank. That will push rate differentials, especially longer-dated ones (Exhibit 4), against EUR/$. We estimate that the initial fiscal risk premium effect could be three big figures, while the subsequent QE effect could be worth around seven big figures.
The conclusion:
In short, we see mounting tensions over Greece as a catalyst for EUR/$ to move near parity in fairly short order, with much of that move driven by rate differentials. If, instead, a compromise solution is found (including possible debt haircuts), we see the upside to EUR/$ as very limited, i.e. on the order of one big figure at most. The reason for this is that the market is broadly expecting an agreement to be found, even with the possibility of a default in the near term on debt repayments coming due.
And of course, going back to the start of the note, a "favorable" outcome pushing EUR higher will be one that "will do little to return Greece to growth" and as a result will force the insolvent nation back to the negotiating table until such time as the Eurozone finally realizes that it desperately needs EUR much lower, not higher, and will do everything it can to achieve that, even if it means "siloing" Greece in a state of suspended default indefinitely if only to eliminate the "risk on" euphoria in the currency pair.
Indeed, as we said last year, the entire escalation over the Ukraine conflict was merely to push Europe to the verge of a triple-dip recession, which in turn was the catalyst that finally greenlighted the ECB's first episode of QE with Buba's blessing (after all Germany's economy was finally on the brink as well and it had little to lose). Well, the next such "catalyst" will come from none other than Greece as per Goldman's punchline:
We encounter many who argue that mounting tensions over Greece could be Euro positive. The short term angle is that risk reduction will lead to a squeeze of Euro shorts, so that EUR/$ could squeeze higher. The reason we don’t believe this is because we think stepped up ECB QE will dominate any risk-off response. Or, to put this in another way, the ECB will not allow the fiscal risk premium to go all that much higher. The medium-term angle is that the Euro zone might be more cohesive without Greece. That rationale assumes that Greece is a case apart, when of course it isn’t. After all, the Spanish unemployment rate is not far behind that of Greece and populist political pressure is also building. The underlying commonality, in our minds, is that “internal devaluation” is very difficult. As a result, we think mounting tensions around Greece could just as well focus market attention on the sustainability of the adjustment program on the Euro periphery.
Whoever would have thought that none other than Goldman would serve as the source of what may be the biggest "conspiracy theory" gambit of 2015...
One final thought: what Goldman wants, its former employee at the ECB tends to deliver.
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Can someone confirm that Greece bonds issued locally turn into Drachma if re-introduced while euro bonds would stay euro-denominated? Therefore if Greece leaves the eurozone they do not have to default as they can print? But it pays off to buy eurobonds as those will be repaid eventually?
IF you remember the incorrectly named voluntary exchange, the official line was that UK legislation Greek bonds would be attracted into the swap as well. Very quietly, no such thing has happened. all those bonds paid regularly, and it was impossible to force a change in the prospectus.
However, there were various currency denominations, not only EUR (one was in CHF, I recall). The fact that they paid on time has been kept very quiet because it would have generated an instant "applicable law premium" in other names, my poor Italy to name one, and that would have become the key indicator of default instead of the bund spread, which the ECB can manipulate to its heart content. that would not have been an issue, if not for the fact that a country in trouble would have seen demand for local bond dry up completely, while there would still have been good demand for UK law bonds. not the time to advertise "fog in the Channel: continent cut off"
Goldman delenda est.
What would Monday be without the Latvian troll posting more anti-putin and anti-russian BS?
That makes sense! Certain intuitions I have have told me there was something going on here. I have been boycotting Greece news but now it makes sense.
If TPTB are US bankers and politicians...why is it that the US, beginning in the progressive era of the 19th Century, has been pressed relentlessly away from its own Laws and Traditions (Popular Sovereignty, Limited Gov't w/ennumerated power, Hard Metalic currency, Government non-interference in the economy, Government non-participation in the economy) and pressed relentlessly and continually for over a century to its distinctly European opposites: Government/Aristocratic Sovereignty, Unlimited Gov't w/unspecified powers, credit currency with a central bank, government managed and regulated economy, Direct government competition with private businesses in entire industries)???????
This is only an indicator.
Indicator of what?
Indicator of who owns the Federal Reserve Banks of the United States. I imagine there are still some Rockefellers there. Probably JPM... but all the evidence is that there are others, the others are foreign, and the others are in the majority.
In the Land of Bankster, all roads lead to the Rothschilds.
IOW the Greeks are right.
This sounds like the Bankster version of sacrificing some people on an altar to the Gods (aka doing Gods work) so that the rest (aka the high priests) can enjoy a better life.
Remind me again how well that worked out for the Mayans.
cash withdrawals in greece limited to 3000 euros per day
Here's what the banksters really want. Commerz bank says Greeks should use gold to pay debt.
http://www.marketpulse.com/20150619/commerzbank-suggests-greece-could-se...
More robbery by the liars.
The Greek people need to tell their politicians that any attempt to release/sell their gold to the EU/IMF or any other alphabet soup named agency, will have extreme negative consequences for any traitor to the Greek nation.
Last drop of blood...
Here's my Conspiracy theory:
What Europe fears most is a revolution. They will try everything in their power to stop it. If they fail, heads will roll. You can count on it.
What Europe fears most is a war.
Internal or external? Maybe both? Either way, the elite heads will roll. Poor people have nothing to lose, everything to gain.
I agree with you... to a point. It really comes down to the word "fear" where I waver. I don't, for a second, believe the Euro braintrust is scared of conflict...hell.. it's been their continental passtime for millenia. No, I think they expect it but need to find a way to "blame the victim". Heads will roll, for sure, it's just whose is the question.
Ever watch vice news?
The whole thing is one massive manipulation, just like the former Soviet Union, markerts are dead, all there is are traders playing the Central Bank Puts, betting on manipulation and QE. The one thing we know about Soviet central planning, is the whole fucker is going down! How we let these giant mega states and mega banks form is a major defect of democracy in the 2000's. The EU is a Soviet Organ of Dictatorship, with a strong overtone of fascism and Orwellian thought control. Organs of propaganda extend now to nearly all major news outlets. BBC being a model of perfect Soviet propagand. Governments, bribed and controlled by the elites, are in the population manipulation business. We are their victims, but victims who mindlessly believe the bullshit we are sold in media.
Short, concise, true and understandable. The one that downvoted you is full of crap.
I agree.
It's all just so much Bukkake Theater.
I think you mean Kabuki Theater.
Strategy of Tension is what I see.
You had 5 PIIGS plus Iceland. France, Germany, Nederlands, Belgium, and the USA get out for free.
So which Pig did they start with?
Greece has been a target of the USA since 1945. In 1947 Congress pass a bill to fight Communism in Turkey & Greece. NATO & the CIA came up with the Strategy of Tension and the Stay behind Armies and the Operation Gladio type activities to bring people back to the political Right and away from the Communists.
TOday Greece is the only PIIGS that is left Leaning.
Germany Hates Communists. Schable Hates Communists. NATO Hates Communists. And the EU only works if countries follow the Lead of the Troika.
And so the Troika set out to Destroy the Greek Culture.
Martin Armstrong says he was involved with the creation of the Euro. He says it has a flaw that he stated early on that they need to consolidate the Debt under the EU for Investors. The EU is not a nation or a union that can be invested in easily like the USA because of this.
Certainly the Troika is now playing countries against each other and you see today Ireland come out on the Side with Schable.
"all there is are traders playing the Central Bank Puts, betting on manipulation and QE."
Isn't it obvious but there again zillions of spins still not convinving retards ? 2% for traders ...an entry fee that even Casinos do not charge.
Draghi looks like one of those Sicilian chaps who would saw off your legs just below the knee with a rusty hacksaw, go to church with his extended family, have Sunday lunch on the terrace of a fine palazzo, then come back to scoop out your eyeballs with the silver teaspoon from his post-prandial espresso.
The Vampire Squid must be short Greek debt.
U need an update in the lexicon when speaking about financial matters.
It's no longer kosher to say 3 big figures, 6 big figures,.......the modern version then reeferring to thousands, millions, billions, trillions...etc, is thus: 1 comma, 2 commas, 3 commas, 4 commas.......and is usually printed as: 1, 2,'s 3,'s and 4,s' for brevity.
You'll thank me sooner.
I think the politics trumps economics explanation much better. As if the EU cares about economic growth. The Greeks wink at Putin and get more money. Who cares who pays it: slaves all of them.
these are the same Cunts who slid greece into the EU with smoke and mirrors in the first place, so now with Greek people suffering and these scum creaming the money in with , and no chance of a single arrest and not a single word from the shit MSM..as usual All forgotten
Silliness unbound, comedy article
I have been saying for months it is all a PR excercise. The ECB wants Greece to quit the Euro and not be seen as throwing them out. The financial ratios for Greece needed to be manipulated during the boom times just to get Greece into the Euro. Everyone has known that this is not sustainable. Kicking the can was great for a few years but this whole saga is now dragging down everything. Even the severe optimists now realize that if there was a solution to the Greek debt problem it would have been proposed over the last few years. I believe the can will be kicked for 2 more months and in August the Greeks will be out. The ECB may even pay the Greeks to quit the Euro so as to save face.