After reading Felix Salmon late last week I felt compelled to share. I don't feel delusional but I still have great conviction about what is coming from our friends in the EU. And even after the latest announcement about a Greek "re-fi deal", the eventuality here seems quite obvious to me.
The fact is the Troika is in the unenviable position of having to decide winners and losers here while keeping foremost in their collective minds that the EU must survive and that there is no retreat from the euro common currency. Survival is the key and that's what gives them a fairly obvious path to what they must do next. That's not to say that they won't be hopping on one foot for a while putting out fires that start unexpectedly based upon nationalistic tendencies and political missteps both past and present.
But they already have a fairly clear picture of how they need this to look when all is said and done. It's as simple as this. Imagine yourself on a plane flying over the Pacific and reaching the mid-point of your flight you realize that based upon your fuel level and all else you won't make the mainland by several hundred miles. Solution: get lighter. The trick is you have to do so without upsetting the hundreds of passengers who might just turn this otherwise slightly stressful adventure into an outright disaster.
After thorough consideration (and not surprisingly in just one meeting) you lay out the final plan that you will have to reduce your altitude long enough to allow a number of passengers to parachute into the ocean to be picked up by passing ships radioed from the cockpit. Hell, you'll even give them a few of those wonderful in-flight meals and some reading materials for their "venture into austerity". When it comes to rafts, they're expensive, gotta' pony up here, and sorry, credit cards only.
Without getting into to how these passengers are chosen (although the rowdy ones in the back are getting on everybody's nerves having borrowed money from some suckers in first-class and then proceeded to clean out the alcohol cart, beginning with the ouzo), returning to our EU situation makes selecting those to be issued parachutes much more obvious. In fact there are one or two who might just volunteer after seeing the first one make only a slight splash on entry. This brings up a very interesting fact about the EU and their common currency. There were never any provisions in any of the EU Agreements for how to exit or be shown the door.
This is particularly notable since every good lawyer (even those who finished law school with Joe Biden's grades) knows that a basic and necessary part of any contract are clauses defining how to end such a coming together. Of course, by leaving out such disruptive distractions in the language, the EU fathers likely wanted to set in place a more certain and permanent tone as in the case of our own constitution (there are no provisions for how states leave the USA. In fact, it didn't end well for those who have tried it). It appears clear, at least to this observer, that there were no provisions provided in order to allow those who may have ended up in the future having to make these decisions an open field to run in and just maybe the element of surprise needed to stay ahead of, and thus able to some extent to manage, financial markets' reactions to such developments.
The key: Do this all in an "orderly manner". There has already been talk for months on end about what may happen. Trial balloons have been floated from everywhere and very likely that has already dampened the eventual harangue. That is, when the news comes that Greece is going to be allowed over some managed period of time (not too long though) to exit the Euro and return to the Drachma, will anyone jump out of their chair and scream that that's a crazy notion and that no one would have ever seen this coming? No. In fact it's what everyone already expects. The only question remaining is when and how the "Greek-ectomy" will be performed.
It would appear from the recent preparation for a bond-swap that the lights are on in the operating room and the call for Dr. Troika has been heard over the intercom. My sense is that Dr. Troika will be entering the waiting room soon to break the news to the family that in order to survive the patient (EU) will have to lose the bad leg (Greece). In order to provide adequate anesthesia for the patient and maybe a little for the extended family during this "Greek-ectomy", Dr. Troika will also announce that he will be spending his own money in order to rehab this lost limb and could possibly consider re-attaching it at some future time.
But a doctor's work is never done and so following this operation Dr. Troika will assure the world that he will be moving quickly down the hall to the E.R. in order to give his now-available full-time effort to those other triaged patients also suffering with the dreaded "DSC-disease" (Debt-Super-Cycle). This new ground-breaking surgical procedure may be applied more than once but in the end the patient will survive.
My sense is that as the announcement is made about the planned operation to "assist" Greece (and likely others) to "re-establish fiscal and monetary self-governance", or some other PC way to make the process sound almost heroic, the Troika need only reassure the world that they are 100% committed to a successful conclusion (spelled: "exclusion"). Most importantly, they will take much of the sting out of the news by spending the greatest portion of their public statements lauding this clearly unavoidable move as the one which will assure the that the eventual economic turnaround in the EU will come that much sooner.
All the debt-troubled developed economies need a shot of that miracle elixir for which there is no substitute, i.e.., growth. The sooner the Troika / EU leaders prune the "EU tree" the sooner the new growth will come allowing them to grow (and likely inflate) their way to the next era of prosperity. Gosh, I'm feeling so much better myself now too.
Now, I'm no Nostradamus but assuming the above process plays out as laid out, there will likely be some disruption that provides for significant investment opportunities in world markets over the balance of 2012 and beyond. There has already been a very strong flow of cash assets out of Europe into U.S. Treasuries and that helped to push UST yields down to historic lows in August of last year. While we have bumped up a bit from there, and the move higher in yields may continue for a short time (maybe 2.15+% on 10 Year UST), when the announced "Greek-ectomy" comes, even with all the assurances previously mentioned, the 10-year Treasury yield may set new lows near or even below 1.5%.
If there were any shorts not squeezed out during this gut-wrenching move they should then double down. USTs will likely lose their standing as the "safest" investment on the planet, to be replaced by corporate bonds from those with fortress balance sheets. The Fed will begin their long march towards inflating us out of our debt as part of their plan to right the economic ship. Treasuries will suffer.
We may also see a short-lived advance in our equity markets as money looks for a safer home and higher yields than governments will afford. These moves will not last forever either and may just mark the ending phase of the formation of a nasty secular head-and-shoulders which has formed over the past 20 years on the S&P 500; a pattern which may take until 2015 or so to complete. It seems a bit spooky that this comes at the same time as we have spent our way into oblivion, now suffering with "DSC-disease" ourselves.
What is equally troubling is that no one seems to be talking about this secular formation on the long-term chart and how we got there. Even more worrisome is the fact that our economy will probably be in an even more weakened position at that time. We may be looking at a very Japanese-like experience for some time afterward. However, this is the stuff of future commentary.
And finally, don't think that this "Greek-ectomy", possible "Portu-gectomy", and 24 hour nursing for the rest of the Euro-patients will end this near-term saga. This little drama that played out in the Euro-E.R. has likely changed these relationships forever. It has also gotten a lot of people thinking about the interconnectivity between the patients both commercial and political. My sense is that the common currency was just the first step towards a future "more perfect Euro-Union".
No one said it would be easy.
Disclosure: I am long VTI, GLD. We are also long FPACX and BERIX.
