Do We Really Know Greece's Default Will Be Orderly? (February 17, 2012)
The market seems to be pricing in an orderly Greek default or a successful "firewall" around the potential instability. Are the unknowns really all known?
The equities market is acting like we know Greece's default will be orderly and no threat to financial stability. It is also acting like we know the U.S. economy can grow smartly while Europe contracts in recession. Lastly, the high level of confidence exuded by market participants suggests we know central bank liquidity is endlessly supportive of equities.
What do we really know about the coming default of Greece? Whether we openly call it default or play semantic games with "voluntary haircuts," we know bondholders will absorb tremendous losses that are equivalent to default. We also suspect some bondholders will refuse to play nice and accept their voluntary haircuts. Beyond that, how much do we know about how this unprecedented situation will play out?
It may be a good time to unearth a famous statement about known knowns and unknown unknowns:
Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns -- the ones we don't know we don't know. (Donald Rumsfeld)
What we know is that the European Union is a model without easy historical precedent. Any predictions made about Greek default or the many financial and political machinations designed to "firewall" Greek default from the rest of the EU are speculations, as there are no good historical precedents to guide our guesswork. To say we "know the European Central Bank has this under control" is to claim knowledge of the unknowable.
We also know the derivatives market for credit default swaps (CDS) is not transparent, so no one can claim to know the risk levels in this market or the possible spillover effects should an "event" trigger instability.
Here is how frequent contributor Harun I. views the CDS market and Greece's impending default:
My contention regarding Greece has been that they cannot be allowed to default because of a tremendously leverage system. This contention remains unchanged.
Here is the link Harun referenced: This is Financial Armaggedon, Lehman X 1,000
One thing that isnít talked about much, although I did receive a note today from UBS regarding it, is derivates related to bond insurance...
I have no idea if this is true or not, but the point is neither does anyone else. The possibility that one bondholder refusing to accept the "haircut" demanded by the Eurocrat lackeys of the banking cartel might trigger a contractually valid demand for a CDS to be paid does not seem priced into the equities market.
Under a slightly more lurid headline is another story making the same point: Forget Greece, Traders Are Worried About Something That Could Send Us Back To The Middle Ages.
As of now, most of the public discussion has centered on potential contagion among the banks as most of the Greek sovereign debit is held by the European banking community.
If the CDS written against Greek debt are not allowed to execute, then that calls into question all CDS insurance written against Euro-based debt. After all, if the banking cartel and its Eurocrat lackeys can essentially negate CDS written against Greek debt, why wouldn't they do the same with CDS written against Portuguese, Irish, Spanish or Italian debt? And if they pull that off, why would anyone trust any CDS written against debt anywhere in the global system?
I have no idea what will happen in the next few months, but I think it is fair to say that what may be unleashed is a known unknown. To be supremely confident that a Greek default will be orderly is to claim knowledge of that which cannot be known.
That smacks of hubris.
As for the American economy expanding smartly while the rest of the global economy contracts--is there any precedent for this premise? Since there is no precendent for the financial crisis enveloping Europe (and it can be argued, China), then whether the U.S. can grow while the rest of the world slumps into recession is a known unknown.
What we do know about global central banks flooding the world with liquidity is that this inflates asset bubbles that always pop with devastating consequences. Since this is known, what is the basis for the confidence that global liquidity will drive equities ever higher without negative consequences? Is this a "liquidity driven rally" or a "blow-off top"? Perhaps the difference between the two is purely semantic.
Once again the risk of liquidity-inflated asset bubbles--oops, I mean "rallies"--is a known unknown.
But what about the unknown unknowns? Markets don't seem to be pricing in any of the known unknowns, i.e. the risk of disorderly default, much less the unknown unknowns.
Maybe the U.S. will expand without regard to Europe or China or Japan, and maybe the Eurocrats will successfully "firewall" the Greek collapse. (Never mind the cost to the non-Elite Greek people--what matters is getting all those politically powerful bondholders and hedge funds paid.)
It seems to me that there is ample evidence that the situation very likely holds
unknown unknowns--but few seem to have priced that into the equities markets.
It often seems like a financial soap opera is playing out on some distant stage,
but the money being made and lost is real--if the players cash out of the game before
the lights go out.
Of Two Minds Kindle edition: Of Two Minds blog-Kindle
"This guy is THE leading visionary on reality.
He routinely discusses things which no one else has talked about, yet,
turn out to be quite relevant months later."
NOTE: contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.
Or send him coins, stamps or quatloos via mail--please request P.O. Box address.
Subscribers ($5/mo) and contributors of $50 or more this year will receive a weekly email of exclusive (though not necessarily coherent) musings and amusings, and an offer of a small token of my appreciation: a signed copy of a novel or Survival+ (either work admirably as doorstops).
At readers' request, there is also a $10/month option.
The "unsubscribe" link is for when you find the usual drivel here insufferable.
All content, HTML coding, format design, design elements and images copyright © 2011 Charles Hugh Smith, All rights reserved in all media, unless otherwise credited or noted.
I would be honored if you linked this essay to your site, or printed a copy for your own use.
|Survival+||blog fiction/novels articles my hidden history books/films what's for dinner||home email me|