What Will You Do When Your Greek Receivables are in Devalued Drachmas?

There are lots of public company quarterly reports I should be writing about, but I am going to step off that track and think, for a bit, the unthinkable.

Or at least it was the unthinkable. But at this point the Eurozone seems to be moving towards two choices, either of which has huge implications for managing any international business.

Let’s review for a minute. What are the three things you can do to get rid of debt? You can pay it off. You can default (a “restructuring” is basically an agreed on default). And finally, at least if you’re a government, you can inflate it away by printing money.
 
The third approach has always been the favorite among governments, because it’s kind of sneaky and doesn’t require politicians to directly take anything away from anybody. It’s happened many times. But don’t take my word for it. Go and read This Time is Different; Eight Centuries of Financial Follies. The point, of the book, of course, is that it’s never different. It won’t be this time. I reviewed the book on my site and you can buy it here.
 
Next, let’s talk about Iceland. Iceland thought it had turned itself into a financial capital, and its banks borrowed lots and lots of money from various British and other European banks. They were, of course, heavily leveraged. So when the cash stopped flowing and they couldn’t renew any of those loans, everything went to hell in the proverbial hand basket. The British and other Europeans howled that Iceland’s government had to make good on their banks debt. Unlike the Irish government, Iceland said, “Uh, actually we don’t.” And they didn’t.
 
Their economy went south and their currency devalued dramatically. It was ugly. But with the competitive boost of a devalued currency, they’ve started growing again.
 
That’s how it’s supposed to work. But Greece, and Ireland, Italy, and Spain, can’t devalue their currencies because they are part of the Euro.
 
Next, let’s talk about the bond market. The bond market is the biggest, meanest, son of a bitch on the continent. It has decided that there’s more risk in these country’s debt, and has pushed their interest rates way up. Italy is up over 7% even with the European Central Bank buying Italian debt (increasing demand and theoretically driving the cost down). Inevitably, higher interest rates make the debt burden even higher and paying off the debt harder. Spain is around 7% as well.
 
So what is Greece, or Ireland or Italy, to do? Austerity! Fiscal Responsibility! Which might work if they could devalue their currency as it is working in Iceland. It’s painful, but it can work. But with this much debt, and no devaluation possible, austerity in the form of spending cuts and tax increases just reduces the economy’s growth, which reduces tax collections, requiring more austerity. It’s a pretty vicious cycle.
 
Here’s the bottom line. There’s too much debt to be paid off. Somebody is going to lose money. They’re just fighting over how much and who.
 
If you’re a debtor nation like the Southern Europeans, you like the inflation solution, because it effectively reduces your debt. If you’re a creditor national like Northern Europe and Germany, you aren’t so enthusiastic because you know inflation also reduces the value of assets. And the Germans, of course have an institutionalized fear of inflation from the hyperinflation of the Weimar Republic. There’s the story of the cup of coffee that cost more when you had to pay the bill then it cost when you ordered it.
 
Remember when Fed Chairman Ben Bernanke told us the subprime crisis would be contained? Then Lehman Brothers collapsed and it wasn’t. I don’t know what will happen in Europe, but it can happen just as dramatically and just as suddenly. Most people seem to think the European banks are a bigger mess than ours ever were. There are simply not two to six trillion Euros (estimates vary) available to bail everybody out (unless they just start printing those Euros) and if there were, it wouldn’t solve any of the competitive issues that lead to this mess.
 
Long term Greek government debt is priced to yield about 30% right now. I’m sure it’s obvious that they can’t pay that, or anywhere near it, and actually service their debt. Something is going to happen. I think it’s either going to be inflation, or one or more countries leaving the Eurozone and defaulting on their debt on the way.
 
In not one quarterly report or conference call I’ve read so far have I seen any discussion of the management of this possible risk. It feels like it’s too uncomfortable to consider. Maybe it’s just concern that talking about it might make it happen. Perception does matter.
 
I doubt any of our major industry players’ sales to Greece are make or break for it. Still, if you’re selling and holding receivables in Euros and have assets denominated in Euros there and Greece suddenly goes back to the Drachma, what exactly happens? Nobody knows. Well, we know the lawyers would make a lot of money.
 
I assume companies are trying to hedge their exposures (not just in Greece) but I’ll bet that’s getting really expensive. I might consider offering discounts for prepayments. I guess you could try and denominate your contracts in dollars, but that might not help. There’s no mechanism for a country to exit the Euro, so they’d be making it up as they go along.
 
I’m not projecting a breakup of the Eurozone, but the possibility of some countries leaving it is certainly higher than it used to be. Frankly, I think they’ll resort to the good old printing press. That’s what’s happened historically, and the powers that be are all issuing coordinated statements about how they will “manage” it; that is, not let inflation get out of control.
 
What am I asking you to do? As always, just to consider the possibility, it’s impact on your company, and your strategy to manage it.

 

 

4 replies
    • jeff
      jeff says:

      Hi John,
      Yeah, it’s not specifically action sports or youth culture related, but it’s going to impact us. My goal is to make it so it isn’t quite such a big surprise when it happens.
      Thanks,
      J.

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