What Greece, China, Cyprus, And Puerto Rico Have In Common

Every situation is unique, but generally the types of asset classes that protect investors in times of crisis are not necessarily the same as those during a bull run.

What China, Greece, Cyprus, and Puerto Rico have in common are not unsurprisingly severe financial problems caused by massive and uncontrolled indebtedness and a political class that is based on entitlements. 

Side-note: for the sake of simplicity we will consider in this article Puerto Rico as a country albeit the island is a US territory, but with a nuance. Indeed, Puerto Rico is an unincorporated territory of the United States which according to the U.S. Supreme Court's Insular Cases is "a territory appurtenant and belonging to the United States, but not a part of the United States.

But foremost, the crisis in each of these countries sharpens geostrategic tensions between US, Europe, Russia, and China. And this field, when financial crises affect geostrategy and vice versa is called geofinance.

Indeed, far worse than economics it is geopolitics that is at stake. Each of these countries occupy a highly strategic location in respectively the eastern Mediterranean, the Caribbean, and North and Southeast Asia. In other words, economics would be the trigger resulting in a geopolitics crises and affecting the geostrategy of the Great Powers involved.

In China, the recent stock market crash which resulted in the Shanghai index collapsing by 30% is bringing nervousness in the market.  And, despite officials and academics trying to talk down concerns about China’s near-term economic outlook, the web in China is bubbling with chats echoing serious concerns people have in relation to slower growth, the unsustainability of the current export-driven model, debt buildup, bubbles in the equity and housing markets, the risk of falling investment, the endemic corruption within the CCP, and the overall international implications of those risks.

In Puerto Rico, notwithstanding their "triple-tax-free" status — exempt from federal, state and local income taxes the commonwealth is carrying an overall debt of $72 billion corresponding to a debt/gdp ratio of 70% versus an average of 10% among US states. The island almost went into default as it nearly missed a $415 million debt payment.

In Cyprus, the economic crisis involved the exposure of Cypriot banks to overleveraged local property companies, the Greek government-debt crisis, the downgrading of the Cypriot government's bond credit rating to junk status by international credit rating agencies, the consequential inability to refund its state expenses from the international markets, and the reluctance of the government to restructure the troubled Cypriot financial sector.

Finally, in Greece, the government-debt crisis (also known as the Greek Depression) started in late 2009. It was the first of four sovereign debt crises in the eurozone – later referred to collectively as the European debt crisis. In Greece, triggers included the turmoil of the Great Recession, structural weaknesses in the Greek economy, and a sudden crisis in confidence among lenders.

In late 2009, fears developed about Greece's ability to meet its debt obligations, due to revelations that previous data on government debt levels and deficits had been misreported by the Greek government. This led to a crisis of confidence, indicated by a widening of bond yield spreads and the cost of risk insurance on credit default swaps compared to the other Eurozone countries – Germany in particular.

In 2012, Greece's government had the largest sovereign debt default in history. Greece became the first developed country to fail to make an IMF €1.6 billion loan repayment on June 30, 2015. At that time, Greece's government had debts of €323 billion.

Now, the commonality between these four crises is multiple:

1. Unsustainable indebtedness and rise in likely defaults: economically speaking the exposure to unsustainable debt build up, amongst others, in the housing sector combined with weakened public finances. Whether you take Greece (177% Debt/GDP), Cyprus (112%), Puerto Rico (70%), and/or China (90% when adding guaranteed debt by central govt), each of those countries is facing huge public sector, a housing bust, ineffective public administrations, and economies losing steam and/ or stagnating jeopardizing repayment as well as refinancing capacities.
2. Weak banking sector, as the banking industry in each of these countries has been non-performing with very high volume of non-performance assets of around 10-15% compared to 2-3% in the Western world. Banks have been kept on a life-line as a result of  equity issuances allowing for a acceptable measure of stability in terms of capital positions. Even in China, where officially on paper, Chinese banks are strong, in reality books are cooked and capital, liquidity and asset quality ratios are deteriorating rapidly.
3. Currency policies that are dictated by fixed exchange rate mechanism: Indeed, while Cyprus and Greece (as well as Puerto Rico) have their monetary policies being decided upon by Brussels (and Washington), China has no convertible currency and has no free floating exchange rate. Also, from a monetary perspective, the small interest rate cut and RRR and margin financing relaxation in China in the past week are similar to the tentative steps the ECB took back in 2009-2011 before the recent wave of aggressive European quantitative easing.

4. Broken promises and lack of political will for reforms: reforms in each of those countries have been delayed or never fully implemented resulting in a public administration and economy that have not adapted well to a changing global world. The political elite in each these countries can be labelled as leaning towards a liberal (in the US meaning of the word) or socialist (in European sense of the word) political agenda.

5. Resurgence of the Fantom of 1929:  stock market crashing down, sharp increase in unemployment and poverty levels, capital controls and bank closures, popular discontent rising, corporate bankruptcies soaring, and governments resorting to populist measures. 
6. Corrupt political authorities: the political regimes in those countries are mired into favoritism and maintain in power solely through hand-outs, entitlements, clientelism, and corruption.
7. Misguided anticipation of risks: whether it is the regulators, the rating agencies or investors initially viewed a financial blowout in those countries as a tail risk, but reality has proved them wrong.
8. High contagion risk: the ripple effects that would be felt far outside the borders affecting mutual fund investors but also contaminating other countries that are burdened with excessive debt but until were able to maintain the confidence of markets.
9. Power games being played out: the game of chicken being played out between (supra)national authorities and local authorities and/ or investors. Indeed, the question who will blink first and fall for pressure? With respect to Greece and Cyprus, will it be the Troika or the governments of each of those two countries? On the Puerto Rican case, will it be Washington who will fall for the sirens of bankruptcy or the island that will be left on its own. And, finally on China, whether it will be the investors or the Central Government it will anyway say a lot about how China manages what is looking like a serious bust.
10. High geostrategic stakes: the crisis in each of these countries sharpens geostrategic tensions between US, Europe, Russia, and China. In the eastern Mediterranean Moscow is on the lookout to fall into grace with both Cyprus and Greece as it would allow Moscow to have for the first time in decades to have direct access to warm water seas. As a reminder, Greece and Cyprus are at the center of the Mediterranean basin. Puerto Rico being in the same basis as Cuba, and some of its neighbors have tested the water of communism, Russia would be keen to exploit any rift taking place between the island and Washington. Finally, on China, a weakening of the economical apparatus of Beijing would ignite a surge in nationalist rhetoric and a political regime that would feel cornered and have nothing to loose. This would make the waters of the South and East China Seas more insecure.  But, China has also links with Greece in the sense that Chinese officials are seriously considering helping out Athenes through the new financial instruments provided by the AIIB; this wold represent a huge stunt in terms of foreign policy for China and would help acknowledge its rise as a great power.
11. Increased uncertainty: there will be uncertainty in world markets until the outcome is known. Even if, with respect to Greece, a compromise is found - averting for now a Grexit - the salvation package will have no structural impact as reforms will be timid, and mostly due to the fact that the debt problem is not solely a Greek problem but a sceptre for the entire EU. Athens is merely the canary in the coal mine. As for China, while Beijing is resorting to a party diktat to try to force markets in China to calm down, this is merely a bandage on an open wound as the core of the problems will still not have been addressed. China needs the free market to operate this 180 turn to transform the Chinese economy from an export led economy to a consumer driven economy, but it seems that it does not want to abide by its rules, thereby delaying necessary reforms and making the time bomb ticking faster. With Puerto Rico, it is clear that Washington does not want to bail-out the island, but this debt crisis is a test for the US municipal debt finance market as within the US other authorities are succumbing to debt, such as Detroit, Chicago, but also California for instance.
12. Victims of ultra-loose central bank policies: They have benefited from the ultra-loose experimental policies that have been pursued by major central banks around the world. Investors are worried that this may be the moment in which asset prices, having been inflated by these experimental central bank policies, revert back to the lower levels warranted by the more sluggish fundamentals (such as economic growth rate, inflation rate and unemployment rate).
13. China is heading for a Greek style of crisis but on a 'grand' scale.  For years, China and Greece have had something special in common: a long cultural history that has helped shape the modern world. And from the late 1970s to this day, they shared something else — a semi-Soviet economic model whereby a large part of the economy has been subject to the direct or indirect control of central and local government. In both countries government has been present in utilities, telecom, transportation, and energy — as owner, financier, entrepreneur, and manager. This has resulted in keeping inefficient enterprises afloat, though more in China, where the government is the outright owner of State Owned Enterprises (SOEs), Town Village Enterprises (TVEs) — producing goods as varied as steel, laundry powder, aluminum and toilet paper. Government has also been present in the banking industry of both countries — controlling almost every major bank, and rationing credit by political fiat rather than by market forces.  In practice this means that one arm of the government lends funds to another arm of the government, and everyone is happy, at least until someone must pay the bill. Then the situation turns ugly. That’s what happened in Greece in 2011, when the country’s semi-Soviet model collapsed, taking down a large and corrupt government that lacked the resources to finance its multiple roles in the economy.
14. Everybody shares blames for the crises in those countries: The political establishments (whether local or Western), lenders and investors, local population on the one hand were very happy with the ways how things were going for the last decades as it seemed like a win-win strategy, but resulted into a drag in reforms, which now that the danger is at the doorstep, have become too late to implement given the structural disease that those economies have been affected with. 
15. Huge stigma: The populations of these countries will carry a stigma and deep humiliation that will be borne for generations to come. And, history shows that nations affected by humiliation, frustration, and stigma do not fare well in terms of neighborhood politics. The former crisis in Cyprus and the current one in Greece already provide a vivid illustration of this threat that aims to show that stigma, frustration and humiliation are leading to challenging the existing geopolitical order. Indeed, Cyprus and Greece's current anger with the politics of the Troika is gradually pushing them into the arms of Moscow. China’s for its part increasingly assertive territorial claims is partially explained by a perception that it was humiliated for a century, and now wants to regain its status of Middle Kingdom. Puerto Rico, despite its dependence on the US is gradually gaining voice to have a referendum requesting a formal independence away from Washington as since the end of the Spanish-American War it has been in the sphere of influence of the United States.
16. Failed states: Greece and Cyprus are known to be failed states (as well as Puerto Rico) as too many citizens have lost faith in the government’s ability to provide even the most basic of services, for reasons mentioned above. But even China is failed state, even though publicly it shows it muscles accompanied with drums and trumpets, given that the Chinese Communist Party, which controls the ultimate power in the country, is deeply shaken. The recent so-called anti-corruption police actions are not aimed at making the chinese society/ economy more accountable and efficient, but these anti-graft actions are merely the result of power games where fractions within the CCP are becoming increasingly antagonistic. And, Beijing has reached an inflection point where its leaders must choose between ushering in a new set of sweeping political and economic reforms or tightening their grip on power. Despite a security crackdown on so-called dissidents (whether on mainland China or in Hong Kong as recent events have shown),  party leaders are gradually losing control over the country. And now that the financial markets in China are plunging causing millions of Chinese households to fall into despair, these same millions will swollen the ranks of protesters that Beijing is so much fearing.