Irrational Greek Government May Encourage Europeans To Purchase Gold

London (Jun 29)  Summary•Greek PM Tsipras call for a moot referendum closes the door for bailout negotiations and virtually guarantees Grexit.

•Referendum is moot because it is to be held 5 days after the June 30 deadline to decide on whether to accept a bailout proposal that no longer exists.

•While ECB is maintaining emergency lending for now, long queues formed in front of ATMs and the Greek government imposed capital controls over the weekend.

•Neighboring Macedonia is the first country to cut financial ties with Greece to insulate against the effects of Grexit. Domino effect might have already started.

•Irrational nature of the Greek government puts the entire European project at risk. This provides an incentive for Europeans to hold physical gold with short term bullish impact on gold.

The European situation changed dramatically over the weekend and this had caused me to change my position on gold. On June 15, I wrote an article titled "Should We Buy Gold On Grexit Concern?" as a reply to a reader's indecision on whether I said buy gold on Grexit because gold is negatively correlated with the expected USD strength but it is also a hedge against financial instability. My assumption back then was that the EU would be able to contain the situation with Greece and hence the financial instability function would be superseded by the rising value of the USD.

After all, the majority of Greeks want to stay within the EU and this was expected to constrain the Syriza government. The current Greek government is expected to make some loud demands for concessions while the EU is expected to push against it for further reforms before dispensing the bailout money to keep Greece in the family. There will be a lot of heat and news stories back home so that both sides can show that they have pressed for the best possible deal. In short, business as usual was expected as it had been for the past 5 months with negotiations being held close to the deadline.

Moot Referendum

However Greek Prime Minister Alexis Tsipras pulled an unexpected move that derailed the entire negotiation process. Tsipras called for a referendum for the Greek people to decide if they would accept the EU's bailout proposal or not. Before we get into the details and reactions to this referendum, consider the simple issue of time. The deadline for the Greek bailout would be on June 30 and yet the Tsipras referendum is on July 5. In other words, the referendum is moot for the simple reason that there will be no bailout proposal to consider simply because Greece had already defaulted!

This referendum had effectively dashed hopes that a last minute agreement can be reached in time by the June 30 deadline. Perhaps the Greek gamble is that the EU would accommodate them by extending the deadline for another 5 days. However this is merely wishful thinking as the sudden nature of the referendum insulted the powerful politicians who had to put their careers on the line in order to carry out the negotiations in the first place against the growing impatience from their people back home.

This is how the Financial Times reported the reaction from 2 key negotiators from the ground. The Chairman of the committee of eurozone Finance Ministers, Jeroen Dijsselbloem, was quoted as saying:

“That is a sad decision for Greece. It has closed the door on further talks while the door was still open, in my mind."

The German Finance Minister, Wolfgang Schäuble, took the hardline on this topic and was quoted to have effectively closed negotiations with Greece over the matter with the following quote:

“The negotiations are clearly ended, if I understand Mr. Tsipras correctly, We have no grounds for further discussions."

There are other angry comments on the group as the various European finance ministers realized that they had wasted a lot of effort on bailout negotiations. There is no need to quote them as the Wolfgang and Dijsselbloem comments had made it clear that this is the end of negotiations and Grexit is only a matter of time.

Capital Controls

As of June 28, the European Central Bank (ECB) remains committed to supply $89 billion euros of Emergency Lending Assistance (NYSE:ELA) to the Greek Central Bank according to this Marketwatch report. However in light of the referendum, the ECB would likely cut off its ELA funding by June 30.

While the ECB is committed to keep Greek banks open temporarily, there had been a massive run on the banks as seen in the long lines that formed once the referendum announcement were made. By the end of the week, Tsipras had to announce capital controls which limited ATM withdrawals to $60 euros a day. In addition, Greek banks are now closed for an indefinite period of time. This is on top of the $5 billion euros that left Greece in April 2015 alone.

This capital control announcement had triggered a decision by Greek neighbor, Macedonia to order its bank to pull out its money from Greek's bank. This is a sign that Greece's weaker neighbors are currently actively taking steps to insulate themselves from the potential fallout effects from Grexit. It should be noted that 20% of Greek banks asset are based in Macedonia.

Conclusion

In other words, the situation on the ground is rapidly spiraling out of control and a Grexit is virtually guaranteed. In this situation, it is entirely likely that financial instability would engulf Europe even if the Troika absorbed the majority of Greek's bad debt. The irrational nature of the Syriza government would multiply the likelihood of a disorderly Grexit as Syriza might impose more than just capital controls.

Surprise is the trademark of the Syriza government and this has been pushed to the next level. Perhaps the root of the problem is that the twin wishes of the Greek people, which is to stay in Europe and to avoid the pain of austerity, are mutually exclusive to each other. They must either stay in the eurozone and take the pain of austerity or they can leave the euro and be free of the austerity demands from their creditors through default. They cannot have both and the fact that they want to have their cake and eat it, too, is one of the primary reasons for chaos.

They are threatening to unravel the whole European project and it would encourage other debtor nations such as Spain and Italy to leave the eurozone. For this reason, there is likely to be legitimate demand for physical gold all over Europe. This can be a potential short term demand for gold as its price is likely to get more expensive despite the rising USD. However the fact that events had been pushed to their climax would mean that we would likely to have a conclusion to the Grexit issue soon.

Over the longer run, a successful resolution would be conducive to the economic development of Europe. Over the medium term, that would reduce the demand for gold on the assumption that the Grexit effect can be contained with Greece itself and not spread to the rest of Europe.

Source: SeekingAlpha