Will Greece lead way to end of eurozone?


By Wouter Klijn

What better way to start a presentation on Greece than by quoting one of its most famous philosophers?

“We must not expect more precision than the subject matter admits,” Partners Group executive vice chair Charles Dallara quoted from Aristotle's The Nicomachean Ethics during a presentation at the PortfolioConstruction Forum's Markets Summit in Sydney on Tuesday.

By doing so, Dallara was criticising the current political thinking about Greece's Brobdingnagian debt and at what levels the country's debt might be serviceable.

And Dallara knows a thing or two about Greek debt.

He was managing director of the Institute of International Finance from 1993 to 2013 and played an important role in reaching an agreement between European countries and financial organisations on the restructuring of Greece’s debt.

“We were in a rather intense discussion the last time Greek debt was restructured about the ability of any organisation to pinpoint a particular target for Greek debt to be sustainable,” he said.

“The IMF (International Monetary Fund) insisted that it was 125 per cent of GDP (gross domestic product), exactly on the head.

“When I tried to convince the Chancellor [of Germany Angela Merkel] that maybe that was being a little bit overly precise, she said to me: 'Well, I'm a quantum chemist and spent 10 years of my life doing research into quantum chemistry. Even in my field, which is supposed to be one of the most precise in all of science, we cannot expect more precision than the subject matter allows.'

“Fortunately, we were able to negotiate a more flexible framework for Greece's debt.”

The current false sense of accuracy in determining a sustainable level of Greek debt is one of the causes behind the current political impasse to finding a solution for Greece's economic problems, he argued.

As Dallara spoke, news came in that the negotiations on the restructuring of Greece’s debt had collapsed, with Greece rejecting the terms of the deal as “absurd”.

Structural problems

Greece's debt is not just a short-lived problem; it is structural and it will have a profound impact on the wider economy of the eurozone, and in extension the global economy, although how exactly is uncertain.

The Markets Summit explored the influence of structural issues like these on the outlook for markets.

Not only did it address structural issues – developments that are not affected by economic cycles, but rather signify a change in how markets or industries function or operate – but it also explored cyclical and secular drivers.

A cyclical trend deals with the impact of the economic cycle on markets, including changes in food prices or employment figures and inflation.

Secular issues capture long-term, deep-rooted trends that can last a decade or two, including lower birth rates, ageing demographics, obesity and the emergence of social media.

The question of which one of these would drive the outlook for markets over the next three to five years was quickly answered at the summit.

During an audience poll in the morning, no less than 70 per cent of participants said all three of these would impact on the outlook, while only 0.2 per cent said none of these issues would affect markets.

"I'm glad only 0.2 per cent said none of the above. They can go back to registration and get a refund," PortfolioConstruction publisher Graham Rich said.

Yet, how cyclical, structural and secular trends would affect investment decisions is less clear cut.

But everyone realised the discussion around Greece's debt would have a far-reaching impact on the eurozone and could possibly only be resolved by Greece’s exit.

“Letting Greece in the eurozone was a real mistake; they didn't need to do that,” Dallara said.

“I've never seen an economy that is as deficient as the Greek economy.

“The Greeks haven't paid taxes since they were ruled by the Arabs.

“It needs to be broken down and rebuilt.”

Falling dominoes

Dallara's views that even the monetary union in itself was a mistake found support from Pyrford International investment chairman Bruce Campbell.

“There is not the slightest chance that Greece will pay back its debt,” Campbell offered.

“It needs its debt written off by half and it needs to have its own interest rates, not German interest rates.

“It needs a weaker currency, but it can't do that without getting out of the euro.

“Something has to change; this is a structural issue.”

But the danger is that once Greece exits the euro, other countries will follow, helped by potentially predatory investors.

“Let's assume that Greece goes ... perhaps next Sunday, because it will be on a Sunday, than Italy will say: 'Hey that is pretty good: you get your debt knocked off and you get your currency back; it is viable.'

“So they'll say: 'I'll have a bit of that.' Portugal will say: 'I will have a bit of that.'

“And that will be it; markets will attack the next weakest and dominoes will fall.”

Yet, the grim outlook does not mean there are no investment opportunities.

Dallara said he still found some interesting opportunities in Europe recently.

“We just purchased a company that prepares packaged foods for elderly homes,” he said.

“It is going quite well and it is playing on the long-term demographics there.”

Selective investments

And that seemed to be the overarching message of the summit: the global economy will become a much more challenging place over the next few years as structural and secular developments reshape markets, yet investors can still make money through selective investments.

But those that stick too close to benchmarks or invest passively will find it hard to avoid the volatility.

Standard Life Investments chief international economist Jeremy Lawson summed it up nicely in his presentation about the potential of a crisis in emerging markets, when he said:

“At a time when many investors are considering investing passively in a benchmark, our analysis emphasises the value, especially at this phase of the business cycle, in being much more focused in selecting particular countries, sectors or companies in order to steer away from the more vulnerable assets to future economic, financial or political shocks.”

Or as UBS Global Asset Management head of investment strategy Tracey McNaughton said during the final debate: “You need to be careful in taking broad exposures.”

For more information on the summit and access to speakers' white papers, please click here.

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