"Kee" Points with Jim Kee, Ph.D.

Markets sold off (declined) globally last week over general concerns regarding growth, earnings, and potential financial concerns, particularly those surrounding Greece’s debt problems.


Greece doesn’t have the money to pay its bills and faces possible default on its debt if it doesn’t get fresh emergency funding by June. Everyone from US Treasury Secretary Jacob Lew to the IMF is urging Greece’s new government, headed by new Prime Minister Alexis Tsipars of the Syriza party, to implement reform measures (e.g. pension system reform, labor market reform) that the prior Greek government had agreed to in 2012 as part of a $259 billion rescue deal.


Concerns over Greece are valid: Greek 10-year bond yields hit 12.49% last week, as compared to Germany’s .07% 10-year yields. Two-year yields in Greece are over 26%, and this inversion (normally long yields are higher than short yields) suggests that investors see a very high risk of default. They are very concerned that the entity’s ability to repay even short-term loans is jeopardized. Looking to short-term rates as an indicator of financial stress is common in financial economics. In his looking back over the 2008 global financial crisis, former Fed Chairman Ben Bernanke talked of how he focused on the TED spread, or Treasury-Eurodollar spread, which is the difference between the interest rates on short-term interbank loans (loans between the large global banks) and short-term government debt or T-bills. As the risk of default on these interbank loans (i.e. “counterpart risk”) increased, interbank lenders demanded a higher rate, and the TED spread rose from normal 10-40 basis point levels to over 450 basis points at the peak of the crisis (don’t worry, its currently at 26 basis points!).


But while the European Union is in much better shape to weather a Greek exit or unmanaged default than it was a few years ago (WSJ), I still don’t think it will happen, because it is still in no one’s interest - Greece’s or the broader European Community’s. My view is that, in the end, Tsipars will do what it takes - the absolute minimum - to secure the funds in order to avoiddefault. Not unlike the US’s debt ceiling debates, there seems to be an almost natural requirement for countries to move towards the brink before the political process moves towards resolution. That tells me that European and US (and Japan and Latin American) debt problems will be punctuating theheadlines for years. But Europe has made progress in other areas, and our Co-Chief Investment Officer Leah Bennett covers some of Europe’s positives in this week’s STMM webcast.


These are shocks, and as Kee Points readers know I tend to agree with the data-driven view of both economies and markets that downturns and sell-offs are caused by (usually random) macroeconomic shocks, big and small. Unfortunately, whenever these shocks occur there are always gloom and doom prophets ready to capitalize on the situation. This was explained in a profound way by financial journalist Helaine Olen in her book Pound Foolish. Olen observed that, "There can be a strange comfort in economic Armageddon. Gurus with their doomsday scenarios bring an odd sort of order to what otherwise could seem like a random series of ghastly events. According to them, all this bad stuff is happening for a reason. And if you understand the reason, their sales pitch goes, you ban be protected from the disaster to come.”


I think Olen’s insight explains a lot more than that. It explains (or helps to explain) why business cycle theories arise from both the left and from the right. For example, there are those who argue that economies would be stable if it weren’t for government-induced shocks, like tax/regulatory changes or central bank actions. And there are also those who argue that capitalist systems are inherently unstable, creating booms and busts through over-speculation or even disruptive innovation. Both have a history of over-predicting economic Armageddon.


The truth, I think, is that shocks can emanate from both government policy and from the private sector (i.e. “exogenous” and “endogenous shocks”). They can also be caused by the interaction of the two, as mentioned above. The key for investors is to think in terms of shocks and to try to avoid a lot of the ideological baggage.