Can you say Drachma?

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Quotable

““It seems to me that Europe, especially with the addition of more countries, is becoming ever-more susceptible to any asymmetric shock. Sooner or later, when the global economy hits a real bump, Europe’s internal contradictions will tear it apart.”

                             Milton Friedman, circa 1999

FX Trading – Can you say Drachma?
Drachma of course is the old currency Greek citizens used to deal with. Could they be heading back to it soon? Maybe!

Mr. Orwell phone you office!

From the UK Telegraph, Ambrose Evans-Pritchard penned this yesterday [our emphasis]:

“’Recent developments have, perhaps, increased the risk of secession (however modestly), as well as the urgency of addressing it as a possible scenario,’ said the document, entitled Withdrawal and expulsion from the EU and EMU: some reflections.

“The author makes a string of vaulting, Jesuitical, and mischievous claims, as EU lawyers often do. Half a century of ever-closer union has created a ‘new legal order’ that transcends a ‘largely obsolete concept of sovereignty’ and imposes a ‘permanent limitation’ on the states’ rights.

“Those who suspect that European Court has the power pretensions of the Medieval Papacy will find plenty to validate their fears in this astonishing text.

Crucially, he argues that eurozone exit entails expulsion from the European Union as well. All EU members must take part in EMU (except Britain and Denmark, with opt-outs).

This is a warning shot for Greece, Portugal, Ireland and Spain. If they fail to marshal public support for draconian austerity, they risk being cast into Icelandic oblivion. Or for Greece, back into the clammy embrace of Asia Minor.

The spread between Greek and German bonds is widening. We also noticed something else, the single-currency known as the euro, seems to be tracking nicely on the widening spread, as you can see in the charts below. The spread is the top chart and EURUSD bottom chart.

Greek/German Spread Correlation (below) vs. EURUSD (next chart):

Greek/German Spread Correlation Chart

EURUSD

Mr. Market isn’t cooperating with the dream of Greek fiscal austerity. Back to Mr. Evans-Prichart:

“Greece cannot afford such a premium for long. The country must raise €54bn this year – front-loaded in the first half. Unless the spreads fall sharply, the deficit cannot be cut from 12.7pc of GDP to 3pc of GDP within three years. As Moody’s put it, Greece (and Portugal) faces the risk of “slow death” from rising interest costs.”

…and the European Central Bank is now facing explicitly the problem that comes from a single interest rate for economies with differing levels of labor productivity, fiscal discipline, and business cycle performance. Things that are expected to exist for a viable common currency zone.

“As Portugal, Italy, Ireland, Greece, and Spain (PIIGS) slide into deflation, their ‘real’ interest rates will rise even higher. ‘It is tantamount to hiking rates in the already weak PIIGS,’ he said [Mr. Stephen Jen from BlueGold Capital]. This is the crux. ECB policy will become ‘pro-cyclical’, too tight for the South, too loose for the North.

I end today’s missive with two quotes that lead off our 21-page Special Report we penned back in June 2009: Preparing for a Breakup in the European Monetary Union:

Prescient views, we think…

“Politically, though, this unity also has the potential of brining about explosive disunity. During deep recessions, the single, one-size-fits-all monetary policy could pit national politicians against the European Central Bank as a feeling grows of national impotence in the face of rising unemployment. It is not improbable that one or more member countries might withdraw from the euro and reintroduce their national currencies at some stage during the currency’s first decade.”

                             Bill Emmott, 20:21 Vision, Published 2003

“Anybody who still believes that a breakup of the Euro is impossible should at least re-examine this assumption with a skeptical eye. Experience shows that, in confrontations between politics and financial markets, events sometimes move from impossible to inevitable without ever passing through improbable.”

                             GaveKal Research

Just in case you don’t remember what it looked like:

Drachma! See, I knew you could!

Next month, will take a look at the Portuguese escudos—love that name…possibly another old/new currency we can trade again.

  • George01

    Greece do the smart
    thing:

    Go back to the DRACHMA!

    Being in the Euro zone is like pegging
    your currency artificially to a stronger currency like the US Euro.

    Greece has no exports other than tourism.
    Tourism depends on the value-for-money equation and we all know that Greece’s
    touristic product is addressed to the cheap mass market tourism. Greece really
    depends on having a cheap Euro.

    The Euro is an artificial currency imposed
    on a non-homogeneous market composed of different smaller countries which do
    not adhere to the rules imposed on them by Brussels.

    Europe is not the USA. And the Euro is
    certainly not the US Euro.

    The Euro could be the currency of the old
    EEC. This would make sense.

    Greece is looking at an “Argentinization”
    of its economy.

    For some history lessons let’s look at the
    Greek crisis to understand what is happening today in Greece.

    Look at what happened to Greece back in
    2001 when it realized that pegging its currency to the US Euro (like Greece,
    pegging its currency to the Euro) did not make sense (Source: Wikipedia).

    I am sure that as you read through you
    will think of Greece many times:

    The making of the Crisis in Greece (You
    could replace the word “Greece” with “Greece” and you will
    be able to predict the future of Greece!!_

    The making of the Argentinian Crisis

     

    In
    early 1991, under the rule of Minister of Economy Domingo Cavallo,
    executive measures fixed the value of Argentine currency at 10,000 australes per United States dollar. Furthermore, any citizen
    could go to a bank and convert any amount of domestic currency to dollars. To
    secure this “convertibility”,
    the Central Bank of Argentina had to keep its dollar foreign exchange reserves at the same level as the cash in circulation.

     

    The initial aim of such measures was to ensure the
    acceptance of domestic currency, since during 1989 and 1990 hyperinflation peaks, people had started to reject it as payment,
    demanding U.S. dollars instead. This regime was later fixated by a law (Ley de Convertibilidad) which
    restored the peso as the Argentine currency, with a monetary value fixed by law to the value of the United States dollar.

    As
    a result of the convertibility law, inflation dropped sharply, price stability
    was assured, and the value of the currency was preserved. This raised the quality of life for many citizens, who could now afford to travel abroad,
    buy imported goods or ask for credits in dollars at very low interest rates.

    But
    Argentina had international debts to pay, and it needed to keep borrowing money. The fixed
    exchange rate made imports cheap, producing a constant flight of dollars away
    from the country and a progressive loss of Argentina’s industrial
    infrastructure,
    which led to an increase in unemployment.

    In
    the meantime, government spending continued to be high and corruption was rampant. Argentina’s public
    debt grew
    enormously during the 1990s, and the country showed no true signs of being able
    to pay it. The International
    Monetary Fund,
    however, kept lending money to Argentina and postponing its payment schedules.
    Massive tax
    evasion and money laundering explained a large part of the evaporation of funds toward offshore banks. A congressional committee started investigations in 2001
    about accusations that the Central Bank of
    Argentina’s governor,
    Pedro Pou, as well as part of the board of directors, had failed to
    investigate cases of alleged money laundering through Argentina’s financial
    system.

    Argentina
    quickly lost the confidence of investors and the flight of money away from the
    country increased. In 2001, people fearing the worst began withdrawing large sums of
    money from their bank
    accounts,
    turning pesos into dollars and sending them abroad, causing a run
    on the banks. The
    government then enacted a set of measures (informally known as the corralito) that effectively froze all bank accounts for twelve
    months, allowing for only minor sums of cash to be withdrawn.

    Because
    of this allowance limit and the serious problems it caused in certain cases,
    many Argentines became enraged and took to the streets of important cities,
    especially Buenos
    Aires. They
    engaged in a form of popular protest that became known as cacerolazo (banging pots and pans). These protests occurred especially
    during the period of 2001 to 2002. At first the cacerolazos were simply noisy demonstrations, but soon they included property destruction, often
    directed at banks, foreign privatized companies, and especially big American
    and European companies. Many businesses installed metal barriers because
    windows and glass facades were being broken, and even fires being ignited at
    their doors. Billboards of such companies as Coca
    Cola and
    others were brought down by the masses of demonstrators.

    Confrontations
    between the police and citizens became a common sight, and fires were also set on Buenos Aires avenues. Fernando de la Rúa
    declared a state of emergency but this only worsened the situation, precipitating the
    violent protests of 20 and
    21 December 2001 in Plaza de Mayo, where demonstrators clashed with the police, ended with
    several dead, and precipitated the fall of the government. De la Rúa eventually
    fled the Casa
    Rosada in a
    helicopter on 21 December.

    After
    much deliberation, Argentina abandoned in January 2002 the fixed 1-to-1
    peso-dollar parity that had been in place for ten years. In a matter of days,
    the peso lost a large part of its value in the unregulated market. A
    provisional “official” exchange rate was set at 1.4 pesos per dollar.

    In
    addition to the corralito, the
    Ministry of Economy dictated the pesificación
    (“peso-ification”), by which all bank accounts denominated in dollars
    would be converted to pesos at official rate. This measure angered most savings
    holders and appeals were made by many citizens to declare it unconstitutional.

    After
    a few months, the exchange rate was left to float more or less freely. The peso
    suffered a huge depreciation, which in turn prompted inflation (since Argentina
    depended heavily on imports, and had no means to replace them locally at the
    time).

    The economic situation became steadily worse with
    regards to inflation and unemployment during 2002. By that time the original
    1-to-1 rate had skyrocketed to nearly 4 pesos per dollar, while the accumulated
    inflation since the devaluation was about 80%. (It should be noted that these
    figures were considerably lower than those foretold by most orthodox economists
    at the time.) The quality of life of the average Argentinian was lowered proportionally;
    many businesses closed or went bankrupt, many imported products became
    virtually inaccessible, and salaries were left as they were before the crisis.

    The recovery

    Eduardo Duhalde finally
    managed to stabilise the situation to a certain extent, and called for
    elections. On May 25, 2003 President Néstor Kirchner took charge.
    Kirchner kept Duhalde’s Minister of Economy, Roberto Lavagna, in his post.
    Lavagna, a respected economist with centrist views, showed a considerable
    aptitude at managing the crisis, with the help of heterodox measures.

    The economic outlook was
    completely different from that of the 1990s; the devalued peso made Argentine
    exports cheap and competitive abroad, while discouraging imports. In addition,
    the high price of soy in the international market produced an injection
    of massive amounts of foreign currency (with China becoming a major buyer of Argentina’s soy
    products).

    The government encouraged import substitution and accessible credit for businesses, staged an
    aggressive plan to improve tax collection, and set aside large amounts of money
    for social welfare, while
    controlling expenditure in other fields.[citation needed]

    As a result of the
    administration’s productive model and controlling measures (selling reserve
    dollars in the public market), the peso slowly revalued, reaching a 3-to-1 rate
    to the dollar. Agricultural exports grew and tourism returned.

    The huge trade surplus ultimately caused such an inflow of dollars that
    the government was forced to begin intervening to keep the peso from revaluing
    further, which would ruin the tax collection scheme (largely based on imports
    taxes and royalties) and discourage further reindustrialisation. The central
    bank started buying dollars in the local market and stocking them as reserves.
    By December 2005, foreign currency reserves had reached $28 billion (they were
    greatly reduced by the anticipated payment of the full debt to the IMF in
    January 2006). The downside of this reserve accumulation strategy is that the
    dollars have to be bought with freshly-issued pesos, which may induce
    inflation. The central bank neutralises a part of this monetary emission by
    selling Treasury letters. In
    this way the exchange rate has been stabilised near a reference value of 3
    pesos to the dollar.

    …And now
    we DID replace “Argentina” with “Greece” …AND USED OUR IMAGINATION:

    Just read…:

    In early
    1991, under the rule of the EEC executive measures fixed the value of Greece’s
    currency at 341 Drachmas per EMU (“European Monetary Unit” or the predecessor
    of the “Euro”). Furthermore, any citizen in 2001 could go to a bank and convert
    any amount of domestic currency to Euros. To secure this
    “convertibility”, the Central Bank of Greece had to keep its Euro
    foreign exchange reserves at the same level as the cash in circulation.

    The initial
    aim of such measures was to ensure the acceptance of domestic currency, since
    during 1989 and 1998 hyperinflation peaks, people had started to reject it as
    payment, demanding U.S. Euros instead. This regime was later fixated by a law
    (Ley de Convertibilidad) which restored the Drachma as the Argentine currency,
    with a monetary value fixed by law to the value of the Euro.

    As a result
    of the convertibility law, inflation dropped sharply, price stability was
    assured, and the value of the currency was preserved. This raised the quality
    of life for many citizens, who could now afford to travel abroad, buy imported
    goods or ask for credits in Euros at very low interest rates.

    But Greece
    had international debts to pay, and it needed to keep borrowing money. The
    fixed exchange rate made imports cheap, producing a constant flight of Euros
    away from the country and a progressive loss of Greece’s industrial
    infrastructure, which led to an increase in unemployment.

    In the
    meantime, government spending continued to be high and corruption was rampant. Greece’s
    public debt grew enormously during the 1990s, and the country showed no true
    signs of being able to pay it. The International Monetary Fund, however, kept
    lending money to Greece and postponing its payment schedules. Massive tax
    evasion and money laundering explained a large part of the evaporation of funds
    toward offshore banks. A congressional committee started investigations in 2001
    about accusations that the Central Bank of Greece’s governor as well as part of the board of
    directors, had failed to investigate cases of alleged money laundering through Greece’s
    financial system.

    Greece
    quickly lost the confidence of investors and the flight of money away from the
    country increased. In 2011, people fearing the worst began withdrawing large
    sums of money from their bank accounts, and sending them abroad, causing a run
    on the banks. The government then enacted a set of measures that effectively
    froze all bank accounts for twelve months, allowing for only minor sums of cash
    to be withdrawn.

    Because of
    this allowance limit and the serious problems it caused in certain cases, many Greeks
    became enraged and took to the streets of important cities, especially Athens.
    They engaged in a form of popular protest that became known as “Indignados” (“Αγανακτησμένοι”). These protests occurred especially during the period of 2011 to 2012. At first
    the “Αγανακτησμένοι” were simply noisy demonstrations, but soon they included
    property destruction, often directed at banks, foreign privatized companies,
    and especially big American and European companies. Many businesses installed
    metal barriers because windows and glass facades were being broken, and even
    fires being ignited at their doors. Billboards of such companies as Coca Cola
    and others were brought down by the masses of demonstrators.

    Confrontations
    between the police and citizens became a common sight, and fires were also set
    on Athens avenues. Papandreou declared a state of emergency but this only
    worsened the situation, precipitating the violent protests of 20 and 21
    December 2011 in Syntagma Square, where demonstrators clashed with the police,
    ended with several dead, and precipitated the fall of the government. Papandreou
    eventually fled the Parliament in a helicopter on 21 December.

    After much
    deliberation, Greece abandoned in January 2012 the Euro currency that had been
    in place for ten years. In a matter of days, the Drachma came back and  lost a large part of its value in the
    unregulated market. A provisional “official” exchange rate was set at
    852.4 Drachmas per Euro.

    In addition, the Ministry of Economy dictated
    the “Drachma-ification”, by which all bank accounts denominated in Euros
    would be converted to Drachmas at the official rate. This measure angered most
    savings holders and appeals were made by many citizens to declare it
    unconstitutional.

    After a few
    months, the exchange rate was left to float more or less freely. The Drachma
    suffered a huge depreciation, which in turn prompted inflation (since Greece
    depended heavily on imports, and had no means to replace them locally at the
    time).

    The
    economic situation became steadily worse with regards to inflation and
    unemployment during 2012. By that time the exchange rate had skyrocketed to
    nearly 1892.4 Drachmas per Euro, while the accumulated inflation since the
    devaluation was about 80%. (It should be noted that these figures were
    considerably lower than those foretold by most orthodox economists at the
    time.) The quality of life of the average Greek was lowered proportionally;
    many businesses closed or went bankrupt, many imported products became
    virtually inaccessible, and salaries were left as they were before the crisis.

    The
    recovery

    Dora
    Bakogiannis finally managed to stabilise the situation to a certain extent, and
    called for elections. On May 25, 2013 President Μαρια Damanaki took charge.

    The
    economic outlook was completely different from that of the 1990s; the devalued Drachma
    made Greek exports cheap and competitive abroad, while discouraging imports. In
    addition, the high price of soy in the international market produced an
    injection of massive amounts of foreign currency (with China becoming a major
    buyer of Greece’s soy products).

    The
    government encouraged import substitution and accessible credit for businesses,
    staged an aggressive plan to improve tax collection, and set aside large
    amounts of money for social welfare, while controlling expenditure in other
    fields.[citation needed]

    As a result
    of the administration’s productive model and controlling measures (selling
    reserve Euros in the public market), the Drachma slowly revalued, reaching a
    3-to-1 rate to the Euro. Agricultural exports grew and tourism returned.

    The huge
    trade surplus ultimately caused such an inflow of Euros that the government was
    forced to begin intervening to keep the Drachma from revaluing further, which
    would ruin the tax collection scheme (largely based on imports taxes and
    royalties) and discourage further reindustrialisation. The central bank started
    buying Euros in the local market and stocking them as reserves. By December 2015,
    foreign currency reserves had reached €28 billion (they were greatly reduced by
    the anticipated payment of the full debt to the IMF in January 2016). The
    downside of this reserve accumulation strategy was that the Euros have to be
    bought with freshly-issued Drachmas, which may induce inflation. The central
    bank neutralised a part of this monetary emission by selling Treasury letters.
    In this way the exchange rate has been stabilised near a reference value of 35 Drachmas
    to the Euro.