Greece's Problems

Greece’s fiscal problems have been much in the news recently. Essentially, the country is bankrupt. They have bond payments coming due this month, and they don’t have enough euros in the treasury to pay back the bond holders.

There is nothing unusual about that. Most governments don’t actually pay off their bond holders when the note comes due. What they do is issue new bonds, and just keep rolling the debt over. Greece’s problem is that they have hit their credit limit. The international financial markets are so nervous about how much debt has already been issued that they don’t want to allow Greece to continue digging the hole deeper.

This is not the first time a sovereign nation has run into this problem. Nations can’t handle their credit cards any better than the average American. The nation state playbook says that in a circumstance like this, you devalue your currency. Devaluation makes your exports cheaper, imports more expensive, and pays back the bond investors with a cheaper currency than they loaned you. The inflationary effects make everyone poorer, including the bondholders, who have to take a haircut on the value of their investment.

This isn’t an available option for Greece, because the Greeks don’t have their own currency anymore. They use the common European currency, the euro. If Greece defaults on its bonds, all of the countries in the Euro zone are in the splash zone. Hence the incentive for the other European Union countries to bail Greece out.

The other European nations, notably France and Germany, along with the International Monetary Fund, have agreed to be the lender of last resort to the Greek government. But there are conditions. They are requiring Greece’s government to reduce the government budget deficit from 13.9% of GDP to 3.9% over the next three years.

With their back against the wall, the Greeks are agreeing to the plan. They are cutting pensions, cutting salaries of government employees, and raising the retirement age. On the revenue side, consumption taxes are being increased one tenth, from 20% to 22%.

How big a cut is this going to be? Government spending makes up about 43% of the total Greek economy. The proposed austerity package of tax increases and budget cuts aims to get that down to about 35%. The government in Greece is going to have to shrink by about 20%. Overall, the average man on the street is going to get 10% poorer over the next couple of years, but the effect will be concentrated for government employees and retirees.

No wonder they’re protesting.

What's in a name?

A deal was recently announced the Russian national oil and gas company, Gazprom, and NNCP, the Nigerian state oil company. The two entities are forming a joint venture to build a $2.5 billion pipeline in Africa.

The joint venture had to have a name, of course, so the executives in charge decided to form a name by smooshing together syllables from the names of the two parent companies. In a decision that will go down in the annals of bad branding history, the new company will be named Nigaz.

Nigaz in Africa. Oh. My. God!

Now, I know neither party in the deal is a native English speaker, but there are branding consultants who will check things like what your name sounds like in various languages, and clue you in about potential missteps before you issue the press release and get business cards printed. I guess the Russians didn’t talk to those guys.

Nigaz. That’s why I spend so much time reading the news. Reality is so much more entertaining than fiction.

You can’t make this stuff up.

Reserve Currency: I'll Reserve Judgement On That

Nouriel Roubini came out with an Op-Ed piece in the New York Times this week. In it, he raises a warning flag. The Chinese, who fund the US government deficit by being the biggest buyers of Treaury bonds, and who have a gigantic stockpile of dollars, are starting to make noises that they don’t want the dollar to be the world’s reserve currency anymore.

In the post-World War II economic system, the dollar became the world’s reserve currency. That means that for globally traded commodities, the deals are priced in terms of dollars. World oil prices are in dollars per barrel.

It also means that for a number of currencies, if you want to change over to another currency, you have to use dollars to complete the two halves of the transaction. For example, to convert Danish kronar into Thai baht, you first trade your kronar for dollars, then trade the dollars for baht.

If you want to be part of the world trading system, you have to keep a stockpile of dollars on hand to fund your buying and selling.

Because everybody has to have dollars, that keeps demand for greenbacks high. This allows the government to keep interest rates low in financing the deficit. It also allows American consumers to run up massive trade deficits, since exporting countries have to accept US currency. Our status as the world’s reserve currency keps the dollar strong, leading to low interest rates and inexpensive imports.

Mr. Roubini’s warning is that unless we get our fiscal house in order, the Chinese currency, the renminbi, will supplant the dollar over the next ten years. Historically, reserve currencies have always come from creditor nations, not borrower nations. If the renmenbi surplants the dollar, our currency will fall preciitously in value. This will cause a spike in interest rates as the government will have to entice investors into continuing to fund our deficits. Also, commodity prices will inevitably rise in dollar terms.

I hate to argue against anyone who is advocating more fiscal restraint, but I don’t find Mr. Roubini’s nightmare scenario to be particularly frightening.

First, to function as a reserve currency, the renminbi would have to be widely traded on currency markets, and before that could happen the Chinese would have to allow it to float, or move up and down in value, vis a vis other currencies. But the Chinese keep the value of their money pegged against the dollar. It is only in the last couple of years that even limited trading of the currency has been allowed.

It is precisely because the renminbi is pegged against the dollar that the US continues to run such a massive trade deficit with China. Otherwise the dollar would already have dropped in value against the renminbi, making Chinese imports more expensive. And the Chinese get something out of the deal. US demand for cheap Chinese imports is driving the extremely rapid industrialization of the Chinese economy.

In addition to the practical difficulties (many of which Mr. Roubini himself lists out), as a manufacturing manager I think the benefits of a falling dollar would vastly outwiegh the costs. Yes, commodity prices would increase. But for the last ten years the Chinese have used an artificially low currency to take market share from companies like mine. Instead of continuing to fight one long rear guard action against off-shore competitors, we could use our advantages of lower freight costs, higher productivity, and shorter lead time to take back business that has been lost. Maybe we could even expand into new markets and products.

If being the reserve currency has allowed Americans, both collectively and individually, to be irresponsible, than losing that status would be a change for the better. It is the difference between empowerment and enablement.

Beer Wars

One of the big stories in the business press this last week has been that the Belgian headquartered beer maker InBev has come out with an offer to buy American beer maker Anheuser-Busch, maker of Budweiser and Michelob. Rumors of this deal have been circulating for several months now, resulting in a rise in Anheuser-Busch’s stock price, which as recently as March was trading for around $45 per share. InBev’s offer is at $65 a share.

The first thing to note is that this deal is almost certainly going to go through. InBev has the financing in place to make an all cash offer. On the day the offer was announced, it was at a price 10% above the closing price of Anheuser-Busch stock the day before the announcement. So the holders of Anheuser-Busch stock (the stock symbol is the cutesy BUD, by the way) collectively have a choice: take $65 a share for their stock, or watch the stock price slide back down into the low $50’s is the deal falls through. Hmmm, $65 or $55. Which one would I take? An old saying that involves wishing in one hand springs to mind right now.

Anheuser-Busch is a family run corporation. The current CEO is August Busch IV, who follows August Busch III. But AB is not a family owned company. The Busch family owns only 4% of the stock. They may have stocked the board of directors with their friends, but if they reject the offer, the board members will have a hard time explaining why they turned down InBev’s offer.

Anheuser-Busch is an acquisition target because of their very success. AB’s market share of the US beer market peaked at 52% a few years back. It has since dropped back to about 50%. If they got any bigger, it would attract attention from the Dept. of Justice Antitrust division. So they have no room to grow in the US market. But what the public stock markets demand above all else is earnings growth. As long as AB was growing, they would have a high stock price. Once growth cooled off, the stock price would sag. The single minded focus on the US market meant that they were slow to grow internationally. Low growth, combined with a lack of globalization, made Anheuser-Busch a target. The weak US dollar makes it a relative bargain.

But not that much of a bargain. Although InBev gets to show earnings growth by folding AB’s earnings in with their current operations, they have to justify paying a premium for Anheuser-Busch to their stockholders. The new owners are unlikely to increase sales, given that they would already control 50% of the market. Brewing is a pretty mature industry, so it’s difficult to see where InBev could squeeze any cost out of manufacturing or distribution. They could save money by cutting back on advertising and brand building in the short run (so long to the Clydesdale commercials at the Superbowl), but longer term that will lead to a loss of market share, and lower earnings.

So aside from increasing InBev’s earnings in the short run, I don’t see any logic for this deal in the long run. This may be why InBev’s stock price has been dropping on the Belgian stock exchange.

If this deal does close, I can predict two consequences: One, a less interesting Superbowl come next February. Two, celebrations by the folks who run Miller, Coors, and Sam Adams.