No Greek Default...Yet!

Well… The warning that I sounded last week regarding the perfect storm for a period of dollar strength, sure has come to fruition…or at least the beginning of it has. And the warning bells I rang for the possibility of a terrorist attack this past weekend, thankfully did not come to fruition; and for that, I am grateful!

Friday saw some real hammering by the dollar on the currencies… Shoot Rudy, even the Chinese renminbi (CNY) weakened versus the dollar! It wasn’t data, because there was none! It all had to do with rumors that were going around that Greece would default over the weekend… That didn’t happen, but the jitters surrounding Greece and a default, are not going away this morning. And all the dissent among members of the European Central Bank (ECB) (and in German Chancellor Angela Merkel’s own coalition) just isn’t helping matters here, folks…

There are also rumors that Germany is making contingency plans to deal with the Greek default… So… What’s going to happen here? Well… This is something that, if it happens, and right now the markets have priced in about a 90% chance of it happening, that will drive almost every investor toward safe havens… The risk aversion will be so strong, that it will look very much like 2008 all over again… In fact, if this has the effect on the markets here in the US like I believe it will, there will be no place for investors to run to… Risk assets will be sold, and cash will be king…

The reason I say that a Greek default will have an adverse effect on the US markets is something I told you a couple of months ago, regarding the credit default swaps that were sold… Guess who wrote those insurance swaps? US institutions… In fact… On June 17th, I wrote in the Pfennig:

Apparently, Eurozone banks own 70% of the Greek debt (bonds)… Which would be very damaging to the Eurozone, and euro for that matter… But… 50% of that exposure is insured against default? And who issued that insurance? US institutions… So, for everyone here in the US that’s rooting for Greece to fail, so you can then pound your chest and say, “See… I told you the Eurozone would collapse” you had better put that insurance news in your pipe and smoke it…

That’s all we need here with our economy teetering toward a double dip recession. Of course, as I’ve explained many times in the past, I don’t really believe we ever left the first recession, for if it weren’t for the government propping up the economy, people wouldn’t have thought we left the recession!

I spent the day at the Cardinals’ game yesterday with my good friend Duane… Duane has always been my “inside guy” for the pulse of manufacturing, as he is a former foreman and now the lead salesman at a tool & die company… When he’s busy, the expectations for manufacturing are high… Well, he told me yesterday that he has nothing on his plate right now… Uh-Oh… That’s not a good sign, folks…

OK… Getting back to the currencies… Well, even gold is getting whacked this morning… But I really don’t expect that to go on and on… What better time has there been to own gold? Europe is falling apart, the US can’t pay its bills, and the Middle East is a powder keg ready to explode… Even if, by chance Greece doesn’t default, and the European Union pulls a rabbit out of its hat, the threat of such an event should be enough to underpin gold!

So… Will Greece decide to leave the euro (EUR)? That wouldn’t be a good thing, folks… Yes, in the long run, the Eurozone would be better off without the small nation with the economy the size of Kentucky’s… But, for now, Greece leaving would be very damaging, because if they left, they would simply default on all their debt, period… That’s right, they would simply tell everyone sorry, but we’re not paying any more interest, and don’t expect principal either… They would return to the drachma, and then devalue the hell out of their currency… But Germany and other countries including the US would be left holding the bag… So… If they are going to default, better to have them in the Eurozone so they don’t begin devaluing their currency…

For… The euro is going to get hammered, like it’s 2008, or 2005, or like it did right after being issued, when it fell from $1.17 to 80-cents… Where will it bottom out? I don’t know… I’ve heard my friend, John Mauldin, say that the euro will fall to parity… Think about that for a minute… You have two currencies, euros and dollars, and they represent the stock of their issuing countries… The Eurozone is roiled with debt, and the US nearly defaulted this past summer… Makes sense for these two currencies to be equal in value, given that both of them have decided to go down the same road of deficit spending…

At least the Eurozone has been doing a better job of cutting deficit spending…

The thing that I keep thinking about though, is the threat of more stimulus by the Fed here in the US. Just last week, St. Louis Fed Head, Bullard, was talking about QE3… I’m surprised that the Fed Heads would call it QE3… Given that QE1 &QE2 didn’t exactly do anything but prop up the stock market, and keep interest rates low, I’m surprised that they would call it QE3… I wouldn’t be surprised to see bond buying, called something else, to throw the markets and public off the scent of returning to QE… But, we’re not that easily thrown off the scent these days!

There are no data reports scheduled to print today here in the US. Tomorrow we’ll see the latest budget deficit numbers, which won’t be good… And the big data event this week will be retail sales for August… In years past, August was a good month, given the back to school sales… But, I’m thinking that this year, August is not going to be so robust… The BHI (Butler Household Index) indicates that while retail sales will be positive, they won’t be robust, which will be a bad sign, given the boost they received from back to school sales…

Well… As I was writing this morning, gold lost $8 more to a $20 loss on the morning. The euro is slipping through the 1.36 handle and so on down the line.

OK… This past weekend, China printed some very revealing data… Front and center, Chinese efforts to stem the rising inflation seem to be working, as inflation eased from a three-year high to 6.2% year on year. The other data print came from the imports, which soared to a 30% increase… I’ve been talking about a change in economic structure in China for a long time now… Changing from an economy that was so driven by exports, to an economy that is domestic driven was the plan, and it looks like they are succeeding, for now…

And for all those people/writers/economists, that have been calling for a collapse of the Chinese economy for a couple of years now, are going to have to wait even more for that to happen, Liu Li-gang, a Hong Kong based economist, said, “This all points to a robust economy, and a hard landing looks an increasingly distant scenario.”

China is the biggest contributor to world growth, folks… So, it’s important for them to maintain a strong economy… There are now some that have come 180 degrees and believe that China will expand more than five times faster than the US and the Eurozone this year…

And then there was this… I know, I know, I should just leave this sleeping dog alone… But it’s my nature to pick… So… I’m going to talk about the “New & Improved” jobs plan that was announced by the president last week. So, if you don’t want to go here, simply skip to the recap… OK… After looking at the details of the jobs plan, I have a question that I’m sure no one in Washington will be able to answer: Just how does cutting the payroll tax create jobs? And then there’s the decision to include $62 billion to pay people who aren’t employed for 99 more weeks… The Fed Reserve recently issued a report that showed that by extending the unemployment period, the unemployment rate remains 1% higher… And, so now we’re going to pay people for almost two years, with money that, we as a country, don’t have! I’m not trying to be insensitive to the unemployed here; I’m just trying to figure out what that has to do with creating jobs!

To recap… There were reports that Greece would default over the weekend, that didn’t happen, but it doesn’t mean it won’t happen. The markets have priced in a 90% chance of it happening, and Germany is making contingency plans to deal with a Greek default… A Greek default won’t be good for anyone, folks… But it will cause a flight to cash, and risk aversion will be all that market participants want to talk about… China printed some good economic reports over the weekend with imports soaring and inflation falling, thus proving all those that called for a collapse of China’s economy 2 years ago, wrong!

Chuck Butler
for The Daily Reckoning

The Daily Reckoning