The Two Scenarios Facing Greece, and What Is Currently Going on in China

July 14 2015

All eyes were on Greece this week, but China wasn’t far behind. The Chinese stock market came crashing down as the country was in turmoil. Investors were even intimidated and arrested in an attempt to halt the crash. What will China’s crashing stock market mean for gold? And what will happen to Greece?

Two Scenarios for Greece and the Euro

I think there are only two realistic scenarios for Greece and the euro at this time:

  • Scenario #1: A Grexit to put an end to the anti-euro sentiment
    The Eurozone countries force Greece out of the euro to make Greece an example for others to see. With that they hope that the subsequent banking crisis in Greece will have a deterring effect on Spanish and Italian voters.

    After all, if Greece leaves the euro, many Greek banks will fail. The result? A massive devaluation and high inflation, or even hyperinflation. But whether or not a return to the drachma will end up in a hyperinflation depends on the reaction of the Greeks; to what extent are they going to fear an even greater devaluation of their currency?

    If we are heading for a Grexit, it is likely that the gold price will rise. That’s the reason why some investors considered buying gold during the weekend, before the market opened.
  • Scenario #2: Eurozone countries and the Greek government reach an agreement
    I consider this scenario the most likely of all scenarios. I expect that the Trojka and the Greek government will eventually come to an agreement. Once more, billions of tax payer money will make its way to the Greeks. However, in return, the Greeks demand a debt relief of between twenty and thirty percent.

    But this scenario will also lead to instability, and a premature end of the euro. Because if the Greeks obtain debt relief, why won't the Spaniards? Or the Italians? Or the Irish? The Portuguese? In 2011, the Irish saw that the Greeks were only going to repay a part of their debt, and asked themselves loudly why they had to repay their public debt entirely. It won't be different this time.

    After the summer, the Spanish elections will unleash. If Podemos, Spain’s twin brother of Syriza, becomes the largest party in Spain, they will ask for debt relief as well. The problem? The financial markets, European governments and the ECB are unable to bear a write-off on Spanish debt.

    In this scenario it is likely that the gold price will, initially, drop sharply. It may even reach a low in dollar terms.

Another, third, scenario is possible. In this scenario the Greek Prime Minister Tsipras decides to abandon his party's wishes, to drop the demand for debt relief, and to agree with all terms that the Trojka imposes on Greece.

It is possible that this third scenario is taking place behind closed doors as we speak. The Greek Minister of Finance, Varoufakis, has stepped down and been replaced. Rumors say that Varoufakis was trying to convince fellow-party members in the Greek parliament to reject Tsipras’s proposals. If the reform proposals wouldn’t have made it through the Greek parliament, the party would have been over.

What Does the Chinese Stock Market Crash Mean for Gold?

While the Greek drama was unfolding, the Shanghai stock market fell into a downward spiral. Some think that this will lead to lower gold prices. What is the relation between gold and the Chinese market crash? And will it indeed have an impact on us?

Before we can even start looking at the potential consequences for the gold price, we will first need to understand the general context. Chinese investors cannot simply invest in everything. In contrast to investors in the West:

  • ...the Chinese are not allowed to invest in foreign assets
  • ...there is a maximum interest rate on savings account at Chinese banks, which is linked to the discount rate set by the Chinese central bank
  • ...investing in bitcoins is prohibited
  • ...the Chinese have to deal with a currency which cannot be freely traded

From time to time, these very restrictions lead to gigantic bubbles in Chinese real estate and stocks markets.

Out of fear for a slowdown in economic growth, the People's Bank of China lowered interest rates. Already since last year, the Chinese central bank has been lowering interest rates step by step. But this encourages the Chinese to look for risky investments. And as you have just seen, the Chinese have few alternatives.

Similar to 2007, this led to a near-hyperbolic rise in stock prices. But these stock price movements are unlikely to last long.

The Chinese authorities responded in a strange way. They did everything they could to prevent any decline in stock prices, even though such this decline was only a return to 'normality.' It was the hangover following the party.

The Chinese government was now trying to cure the hangover by serving more alcohol. It then blamed its metabolism for trying to break down the poison in its system.  

They went as far as to forbid major shareholders to sell their stocks for the coming six months. There was also a witch hunt to intimidate and arrest 'malicious sellers'. 'Short selling' was forbidden, despite all of the evidence that such measures do not help.  

Seven years after the Chinese stock market bubble, it is the same story all over again. It has taken seven years for Chinese retail investors to forget the (figuratively speaking) bloodbath they experienced back then. And now masses of retail investors are incurring large losses once more.

After the bubble in the Chinese stock market, the time may have come for a new bubble in one of the few investments that Chinese investors do have access to: gold?

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