Essential investment lessons from the Greek crisis

You may not think that what happens in Greece is important to you. But it is. This long saga of failure contains many important lessons for all savers and investors around the world. Today’s article is slightly longer than usual, but contains important guidance for anyone serious about protecting and investing their wealth.

As you probably know by now, the desperate situation in Greece is reaching a climax. Greek banks are closed this week and capital controls have been put in place to try to prevent any more money fleeing the bankrupt country. The Greek stock market is also closed for a time.

Cash withdrawals have been limited to just 60 euros a day, although electronic payments can still be made. Greece will have a referendum on Sunday to vote on whether to accept proposals from the country’s lenders.

As I write the the Greek prime minister is reported to be on a plane to Brussels, in an apparent last ditch attempt to secure a deal. Ultimately, whatever happens, it hinges on the dark art of politics. Trying to predict the outcome make no sense.

Most people outside Greece probably think none of this is relevant to their own situation. But all economic crises contain highly valuable lessons for savers and investors…

Most people outside Greece probably think none of this is relevant to their own situation. But all economic crises contain highly valuable lessons for savers and investors, wherever they live in the world and whatever they invest in.

There were big moves in financial markets on Monday after the latest Greek news broke. Stock markets across all regions of the world typically fell between 2% and 4%.

Although the Greek stock market is closed for a time, the Greek ETF, the Global X FTSE Greece 20 ETF (NYSE:GREK) plunged over 19% in just one day. This is because it still trades on the New York Stock Exchange.

At GREK’s closing price of US$9.49 that means it’s down 13% from the US$10.92 closing price on 1st April. That was when we warned that just because the Greek stock market had already fallen 95% from its October 2007 high didn’t mean it was time to buy (see here for more).

Crises usually offer great opportunities to buy investments at bargain prices. But they can kill you if you get in too early. You need to examine each situation carefully before you Take a “crisis vacation” with your investments.

Between the start of April and now Greek stocks have been incredibly volatile, as prices have reacted to the latest announcements or rumours. The situation remains highly speculative and we continue to recommend that private investors stay away until there is more clarity. Even then it may be sensible to stay away, depending on events in the coming days and weeks.

Greek government bonds plunged as well yesterday. Yields were up sharply between 27% at the long dated end (30 year yield up from 8.5% to 10.8%) to 42% at the shorter end (5 year yield up from 15.6% to 22.2%). This means that bond prices fell by a similar percentage.

(Most bonds pay a known, fixed stream of future cash payments to bond owners. The relationship between the price of the bond, on the one hand, and the size and timing of those future payments, on the other hand, determines the yield on the bond. So as bond prices fall yields rise, and vice versa. A lower price means a buyer pays less to own those fixed future cash payments. When a bond default looks imminent the yield spikes higher and the price falls hard to reflect the chance of not receiving some or most of those future cash payments.)

In April last year, here at OfWealth we expressed amazement that the obviously bankrupt Greek government had just managed to borrow 3 billion euros (US$4.1 billion at the time) at an interest rate of just 4.95% (see Bombs, beaches and bonds). As of yesterday the yield on equivalent five year bonds was up by four and a half times to 22.2%. Others now understand the risk.

Government bond yields in other indebted Southern European countries rose sharply as well on Monday. In all of Spain, Portugal and Italy the yields on 10 year government bonds were 11% higher than their previous close.

(To be clear, I don’t mean yields increased by 11 percentage points. For example, the Spanish yield went from 2.10% to 2.34%, meaning it was 11.4% larger at the end of the day than at the previous close. By they way, that’s also an insanely low yield, since Spain’s debts are 98% of GDP.)

There was a big flight to safety into German government bonds, known as bunds. The 10 year bund yield collapsed from 0.92% to 0.74%. That may be a move of only 18 basis points, or 0.18 percentage points. But when yields are already at such compressed levels it translates into a huge one day price move. (A “basis point” is financial lingo for one hundredth of a percentage point, or 0.01%.)

This means the 10 year bund yield was 20% lower on Monday than at the end of the previous trading day. The price will have increased by a similar amount. Since bund yields have been rising sharply in recent weeks, and prices falling, it’s fair to assume that many investors, such as hedge funds, will have been short bunds to profit from the trend. This sudden reversal will have caused massive one day losses for anyone caught in that position.

(“Short selling” involves borrowing an asset from an investment bank, simultaneously selling it for cash, and then hoping to buy it back in the future at a lower price before returning it to the bank. It’s a way of betting that an asset’s price will fall. It’s a highly specialised area of trading and usually best avoided by private investors, even if made available to them by brokers.)

So what can we learn from the Greek crisis? As it turns out, quite a lot.

For a start this whole business in Greece seems to have caught a lot of people by “surprise”. This is despite the problems taking a prominent place in media headlines for weeks, months…even years.

There seems to be some blind faith that things will all turn out for the best…or that the government will sort it out…or that it can’t really be all that bad.

It never ceases to amaze me how people fail to act in time when financial crises are building. There seems to be some blind faith that things will all turn out for the best…or that the government will sort it out…or that it can’t really be all that bad.

Or even worse, people just don’t take care – which is another way of saying they aren’t taking responsibility for their own financial situation. Unfortunately that doesn’t stop them from blaming others when things go bad.

The Greek situation has been building for years. This is a country with a massive public debt burden (177% of GDP) that’s suffering a deep and prolonged depression (unemployment 26%, and twice that for young adults). It’s also locked into an inflexible multi-country currency, the euro, on which it has little influence.

What are the odds of the debt being paid back in full? Virtually nil. When things are so out of whack they eventually have to come to a head, which is why they have. So why the big surprise?

Yesterday the Bloomberg website showed a short interview with some deluded young Greek fellow, described as a “business consultant” but with the spark of socialism in his eyes.

He said he was “very angry” and that on Friday he had transferred a “substantial amount” of his savings into the National Bank of Greece from an account outside the country at a bank in London. Apparently his emotions had swamped basic common sense.

This poor sap appeared to think this was a valid way to express his political opinion and support the government. Perhaps it is. But it’s also an incredibly stupid move in financial terms.

If your country is in crisis, and there’s a big risk of currency devaluation and all the rest of it, you want to get as much money out of local bank deposits as possible – before it’s too late. Many Greeks have been doing just that in recent weeks, but this guy doesn’t appear to have got the message.

Remember: bank “deposits” are not cash kept at the bank. They are loans to the bank. That’s why banks report “customer deposits” as liabilities on their balance sheets. It’s money they owe to customers. Like all loans they can default. Many countries have deposit insurance schemes in theory, but they are often inadequate.

Plenty of developed countries are likely to be hit with financial crises in coming years, and a lot of people will be caught out. This is despite the global crisis that unfolded between 2007 and 2009, when banks were bailed out. Many less developed countries are already used to regular crises, and their people are better prepared for all eventualities. They’ve learnt from hard experience not to be complacent, or to trust the “system”.

All it will take to see more crises is for governments to continue piling on debt, or for bond yields to rise a couple of percentage points (making interest costs much larger on new borrowing to cover maturing bonds), or a combination of the two. There are candidates for crisis across much of the developed world including Japan, the USA and much of Europe.

…politicians and central bankers saying there is nothing to worry about. The mere fact that they feel the need to say those things means there is a big problem.

Well in advance of the crunch point there are usually plenty of warning signs of impending doom, such as politicians and central bankers saying there is nothing to worry about. The mere fact that they feel the need to say those things means there is a big problem.

In Greece’s case it has been the massive, unpayable debt burden plus a deep, grinding depression and the inevitable political reaction at the polls. The hard line socialist government that was elected this year, with a mandate to reverse austerity, has (so far) refused to blink in the face of pressure from Brussels. Politics is often a real wild card in these extreme situations.

We all need to be alert to the risk of crisis, wherever we live. Here are the essential steps that every saver and investor should take to protect themselves:

  1. Always keep a modest stock of physical cash at home in case you can’t make withdrawals from the bank. If crisis looks imminent, increase it. (See more on this topic from our friend Bill Bonner, at Bonner & Partners.)
  2. Own some physical gold coins, hidden close at hand. These can be sold or bartered for essential goods if no one will accept cash. They’re also a long term store of value.
  3. Have some assets overseas as insurance against domestic meltdown. As a minimum this should include foreign bank deposits or physical cash in safety deposit boxes. You can also have gold bullion in safe storage (see BullionVault for one service that we like), foreign brokerage accounts and overseas real estate if you can afford it. Some countries, such as the USA, deliberately make geographical diversification hard for their citizens via onerous regulations and tax reporting. But do it if you can.
  4. Invest across a wide range of assets to minimise the risk of being wiped out by any market meltdown. These can include cash, deposits at multiple banks, a diversified portfolio of international stocks and shares, real estate and much more. Our Wealth Tree infographic shows 50 different way to invest.

Greece’s problems, and the drama being played out in the media, may seem remote from your own personal situation. But they are a reminder of what we all need to do to protect our hard earned wealth from any and all eventualities. Don’t leave it too late to put the pieces into place.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.