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Greece or China: Which is the Bigger Worry?

Investopedia logoInvestopedia 09-07-2015 Dan Moskowitz
A look at Greece, China and other economic concerns, as well as how to invest given the current environment. © Thinkstock A look at Greece, China and other economic concerns, as well as how to invest given the current environment.

Greece is currently facing a debt crisis, but it’s not Greece that should frighten you.

The Greece Situation

Greece has gotten to the point where Greek banks have closed and people can only withdraw a maximum of 60 euros from ATM machines.

The Greek people recently rejected a new draft bailout in a referendum. Will this give Greece more negotiating power? Nobody knows for sure, but we do know that the Greek Prime Minister, Alexis Tsipras, will be addressing European Parliament on July 8, 2015. There is no telling what Tsipras will have to say, but he has already stated that he wants to cut Greek debt by up to 30% with a 20-year grace period. (For more, see: Alexis Tsipras Profile: Can He Impact the Euro Economy?)

Chancellor of Germany, Angela Merkel, is being pressured to bail out Greece. However, others close to Merkel insist that this will lead to the failure of the Eurozone. This is ironic since the fight had been to keep Greece in the Eurozone. France is still in that camp – wanting Greece to remain in the Eurozone.

Germany is the largest holder of Greek debt at $68.2 billion, and many Germans see Greece as a black hole, not wanting to add to that total. (France is the second-largest holder of Greek debt at $43.8 billion.)

The European Central Bank, which owns $18.1 billion in Greek debt, continues to put pressure on Greek banks to offer more security for emergency loans, and the European Commission wants Greece to raise taxes and cut welfare spending. (For more, see: 3 Ways to Trade the Greek Default.)

The real problem isn’t Greece itself; Greece only represents 0.38% of the global economy. The real threat is twofold. If there is a bailout, then European nations that are already struggling will be put in a more precarious situation. If Greece leaves the Eurozone, the concern is that other countries will follow.

The truth of the matter is that Europe is fighting against deflation. This is why the ECB has been pumping money into the system. Whether there is a Grexit or not might have a temporary impact on what takes place in Europe from an economic and political standpoint, but it won’t be able to prevent deflation across much of Europe. (For related reading, see: Don't Let Fear of a 'Grexit' Keep You Out of European Stocks.)

The most frightening aspect of Greece’s current situation is that it has the potential to be a preview for the United States. Currently, Greece’s Debt-to-GDP is 175.1%. The United States isn’t that far behind at 101%. But the real issue is deleveraging while also having to fund future entitlements. Unless actions are taken now domestically, we could find ourselves in a similar situation down the road. The only way to deleverage is for taxes to be raised and entitlements to be cut, both of which will hurt consumer spending and GDP. (For more, see: How a Greece Crisis Affects the U.S.)

All that said, Greece and domestic debts/future entitlements aren’t the biggest threat to the global economy at the moment. That title belongs to China.

China Bubble?

Those Debt-to-GDP ratios above might have looked worrisome, but they’re nothing compared to China, which has a Debt-to-GDP of 282%. Remember, China is the second-largest economy in the world, and it has significant ties to the United States from an economic standpoint.

For example, in 2014 China invested $128.5 billion in the United States, and the United States invested $92 billion in China. (Source: United Nations Conference on Trade and Development). More specifically, keep in mind that the Chinese consumer has been willing to pay a premium for American-made goods, including technology. (For related reading, see: Where is China Investing in the U.S.?)

Also keep in mind that China has a shadow banking system. Therefore, we don’t really know how accurate the numbers are coming out of China. We can safely assume that if they’re inaccurate, they’re made to appear better than what reality suggests, especially since China has been building ghost cities to show GDP growth. That’s going to be a serious surplus of real estate, which should lead to the biggest real estate crash the world has ever seen. (For related reading, see articles: China's State Administration of Foreign Exchange and Introduction to the Chinese Banking System)

That’s not all. Many Chinese people have leveraged their homes to buy stocks, and many others have quit their jobs to trade stocks. This is reminiscent of the dotcom bubble. But there’s one major difference. While profits were nonexistent for many internet companies during the dotcom bubble, credit wasn’t a major problem. In China, credit has expanded faster than in any economy in history.

When comparing Greece to China, it’s important to note that the United States “only” owns $11.3 billion in Greek debt. With China, the two economies are connected and contagion is a likely scenario. This is on top of other domestic concerns, including high public and private debt totals, reduced consumer spending, increased health insurance costs and a student debt crisis. But the domestic problems don’t end there. China might be the biggest threat, but it’s not the only threat. (For related reading, see: The Reasons Why China Buys U.S. Treasury Bonds.)

Puerto Rico

All the big news is about Greece, but it should be about China. Or at least about Puerto Rico. Remember that the United States owns $11.3 billion in Greek debt? Well, the United States owns $72 billion worth of debt in Puerto Rico. And since Puerto Rico is a U.S. territory, many of the bonds are traded in the U.S. municipal bond market. Puerto Rico’s bonds looked attractive to many investors because they were tax-exempt, but it’s better to pay taxes than to deal with the prospect of postponed bond payments. Bonds in Puerto Rico are now seeing skyrocketing yields.

As per the U.S. constitution, Puerto Rico can’t file for bankruptcy. So far, Puerto Rico has cut pensions, hiked taxes, increased water costs and reduced the education budget.

You might be thinking that $72 billion isn’t a massive debt problem on a relative basis compared to our own government’s debt, which stands at approximately $18.2 trillion. But it’s still a bigger problem than Greece, and like Greece, it can be a preview of things to come on a much larger scale. China is already showing its feature presentation.

How to Invest

In the first sentence in this article, the phrase “debt crisis” was used. You will likely hear that phrase a lot more in the coming years, and it won’t just apply to Greece, China and Puerto Rico. It will be a global phenomenon, which will lead to global deflation. If that’s the case, where do you put your money on the long side? When it comes to stocks, generally, you don’t. (For more, see: How to Invest in a Teetering Stock Market.)

If you’re looking for an investment on the long side, consider short-term U.S. Treasuries or the U.S. Dollar (this would be temporary). If you really want to go long stocks, then you can invest in large-cap/dividend-paying stocks where you can implement a dollar-cost averaging strategy, but choose companies that were resilient during the last crisis and have a long history of raising their dividend. Another option is to invest in hot industries, such as healthcare (be selective) and cybersecurity. Unless a product or brand is on fire, stay away from consumer discretionary stocks. (For more, see: Best Medium-Term Investments for Market Jitters.)

On the short side, I still think the Shanghai Composite Index eventually hits 2,000, but it could be a volatile ride. I can only hope you read my previous articles about shorting Chinese stocks over the past few months. Commodities will also perform poorly in a deflationary environment. And given the current situation in Europe, it should only be a matter of time before EUR/USD reaches parity, but it could take a year.

Cash is also a good option because we’re facing deflationary – not inflationary – pressures.

The Bottom Line

Greece is getting all the headlines, but that’s because it’s current, easy to debate and sensational. While all this is taking place, Chinese stocks are being punished relentlessly, which, from a logical perspective, will have a much bigger impact on the global economy. The U.S. market will be seen as a “safe haven” for a little while, and stocks might offer some resiliency, but going long stocks in this environment would be risky. (For more, see: The Coming Stock Market Decline: What to Expect.)

Dan Moskowitz is currently long YANG. 

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