Overseas Opportunities?

On the island of Puerto Rico, the governor announced that its $70 billion debts were “not payable.” Despite the small size of the Puerto Rican economy, its bonds are strangely important in the US bond market. They enjoy this status because they are not subject to federal, state, or local taxes. The result is that a large number of investors and mutual funds own Puerto Rican bonds. In any other month, the Puerto Rican governor’s warning would have been major news, but there was a debt crisis in Europe that stole all the headlines.

The Greek debt negotiation involves three major players: the Greek government, the International Monetary Fund (IMF), and the negotiators from the Eurozone. The Greek government points to the failing Greek economy and makes the case that drastic cost-cutting measures are strangling any hope of recovery. Specifically, the terms of the Greek bailout require the government to run large surpluses, even while its tax base collapses during this prolonged recession. Further angering the Greek people, creditors are demanding that surplus be achieved largely through cuts to government pensions and social programs.

Meanwhile the IMF and the Eurozone point to Greece’s large debts and insist that Greece must continue to cut costs until it can afford to pay creditors without bailout assistance. The difficulty is that both sides are correct. Greece needs to take its debt service more seriously, but it is hard to imagine how the Greek economy can recover under such strict austerity measures. By month’s end, the Greek debt crisis reached a boiling point. The IMF refused to release any more funds, Eurozone negotiators issued ultimatums, and the Greek government rejected another “final offer” from its creditors. The Greek government scheduled a nationwide vote on the creditors’ offer for July 5, but the leadership knew that they would start to default on their loans before the first ballots were cast. While a deal is still technically possible, it appears that investors should brace themselves for the economic upheaval of a Greek exit from the Euro.

Meanwhile in another part of Europe, the Iran nuclear negotiations seem to be going well. By the end of the month, US negotiators indicated that they were putting the finishing touches on an agreement. Investors noted that early reports indicate that all economic and trade sanctions on Iran would be lifted in the first phase of the negotiated plan. This is important because it would allow Iran to sell its oil on the open market again. After years of sanctions, Iran is unlikely to be concerned by low oil prices and the entrance of a major oil producer to the market could drive energy prices even lower.

The Chinese stock markets hit a record high on June 12, but they retreated 22% from that point before month’s end. The People’s Bank of China (PBoC) seemed to anticipate this pullback and took action, but its rate cut was not enough to prevent the decline. As it continues to recover from its recent debt crisis, the PBoC is walking a very delicate line. On the one hand, it is attempting to get companies to reduce the reliance on debt. On the other, it is trying to keep investors happy, which means that any debt reductions need to be gradual and should not come at the expense of prospective growth.