It was just 3 years ago that bond holders took a “haircut” in order to reduce the debt burden in Greece. As you can see in the chart below, the relief was short lived. So here we are again, at the precipice of another Greek tragedy. Today, the problem has both economic and social aspects to it.

Economic Problem:

In a nutshell, the problem is Greece falsified its data to gain entry into the European Union (“EU”). The EU knew Greece was falsifying its data, but accepted Greece because they wanted to grow the Euro Zone. Greece lived large, running up debts that it had no chance of paying off. Six years ago, the EU attempted to correct the problem through various austerity measures. Over that six year period, unemployment has gone up threefold, GDP has dropped more than 25% and individual tax rates have risen significantly. The current tax brackets are 27% (from 12,001 to 30,000 euros), 37% (from 30,001 to 75,000 euros) and 40% (above 75,000 euros) while the VAT (sales tax) has risen and is now at 23%. Given these results, what is the solution the IMF and the EU are now proposing? Believe it or not, the same formula that hasn’t worked over the last 6 years – austerity and higher taxes.   Insanity is doing the same thing over and over again, expecting a different outcome.

The IMF’s formula for helping countries out of debt is fairly simple, but not necessarily productive – cut spending and raise taxes. The major factor for growth the IMF relies on is a devaluation of the local currency. The problem for Greece and the rest of the EU is that this formula does not work because of the common Euro currency. What Greece needs is a growth strategy like Russia had in the early nineties when it actually cut taxes to a flat 15%. What happened when that plan was enacted? Tax receipts went up because taxpayers didn’t feel compelled to hide income with such a low tax rate. Greece is a cash paying society because of the high rate of taxation.   So the solution is to raise those rates?   Scotty, beam us up!   Greece now has an economic choice to make; either comply with EU and IMF reforms and suffer through more years of depression, or leave the EU, re-establish and devalue its own currency and hopefully grow the economy and tax base. This is obviously a difficult choice but we are most concerned about the social implications of this situation.

Social Problem

Three years ago we surmised that the biggest problem with the EU was the rise of social unrest and the possibility of war. Keep in mind, Germany never wanted to be the leader of the EU because it didn’t want to be perceived as taking over – memories of World War I and II. However, Germany now leads by default because it is the strongest economy in the EU. The social contract of the EU is crumbling around it edges and the new Greek government under Alexis Tsipras is one of the manifestations. Tsipras started with a bang as his first official act as Prime Minister was to lay flowers at the tombstone of those Greeks that died under German Nazi rule. Now he is stirring the pot even more by accusing the EU & IMF of blackmail. Just look at some tweets Tsipras has sent the past few days:

• The dignity of the Greek people in the face of blackmail and injustice will send a message of hope and pride to all of Europe.
• With the support of our people, we will reject the ultimatum before us that is an affront to Europe’s democratic traditions.
• Neither the use of threats & blackmail nor trying to incite panic will change the will of the Greek people to live with dignity.

These actions clash with the EU’s goals of cooperation and conflict avoidance. A couple of anecdotes also help to emphasize the point that the real issue in the Eurozone may be more social than economic. Last month, Jim was in North Carolina for a wedding and a couple was there from Britain. The husband is a collector of toy soldiers and very versed on wars around the world.   When Jim asked if he was happy that Britain was not part of the Euro, he responded with an emphatic “No. Britain needs to be a part of it”. When asked why, he said “We need to be a part of it to help avoid war”. At the Morningstar conference last week, an international fund manager that attended the conference mentioned hearing the same sentiment relative to France and Germany. They have been involved in 2 major wars in the last century, and they believe having a common currency will help prevent conflicts from happening again. These stories reflect a couple of “signals” the THOR investment team has been able to include in our ongoing analysis of the market.

What does this mean for portfolios?

Whether Greece stays or leaves the EU, we believe market volatility, which had been suppressed by QE, is back. Monday’s retreat in the NASDAQ was the fifth three-standard-deviation move that has occurred in the last 18 years. The previous moves were in 1999, 2000 and twice in 2007. The move doesn’t mean the market will collapse, but it is a cautionary signal. We like volatility because it offers opportunity. We will be looking for opportunities that may result from the situation in Greece and Europe overall, but your portfolio has been positioned to take advantage of potential market dislocations.

Book of the Month – Signals – the breakdown of the social contract and the rise of geopolitics, Dr. Philippa Malmgren

When people ask about investing, we tell them that it is half science and half art. This book wraps economic, social, and political items together to demonstrate the importance of looking for signals in the economy. What are the signals of Tsipras’ tweets? Is it just a negotiation ploy, or is it the thread that unravels the EU? One of the most successful economic times in the United States was under the longest serving Federal Reserve Chairman in history, William McChesney Martin (1951-1970). Not only did we have stable money, but great economic growth. He is famous for his quote “The Fed’s job is to take away the punchbowl before the party ends”. Martin was successful because he routinely looked for signals outside of Washington to make adjustments before they were reflected in government statistics. He warned Congress about the need to select Federal Reserve Chairmen who would incorporate daily signals into their decision making process,   something we believe is missing at the Federal Reserve which is “data dependent” today. Whether you are an investor, consumer, business owner or retiree, this book is a good read on why you need to look for signals in your everyday life.

Sincerely,

Your THOR Team