Why a Grexit Is Still Where the Greek Debt Crisis Is Headed

Greek debtStocks around the world were in the green Monday as Greece agreed to the latest bailout - its third - and the threat of an immediate default and "Grexit" from the Eurozone faded.

Or so goes the thinking.

But the problems at the root of the Greek debt crisis have in no way been "solved."

Both Greek and European Union leaders are guilty of not only kicking the proverbial can down the road but doing so, according to former German Economic Minister Karl-Theodor zu Guttenberg, "up a hill and wondering why it keeps rolling back on its foot."

I couldn't agree more strongly.

The entire premise behind the euro and the EU, in particular, is based on one of mutual economic strength through cooperation and a common currency. According to Bloomberg, Greece's domestic GDP was about half of Germany's in 2001 when it joined the euro. Now, it's 40% worse.

A Grexit is the only way out here.

The Case for a Grexit

Greece needs it to re-establish sovereignty and rebuild what little growth the nation has available to it. The EU needs that to happen because the European Central Bank (ECB) cannot continue to establish a buffer against future catastrophes forever.

That seems logical. Yet politicians are fighting it because they fear another country would make a break for it once a Grexit becomes a reality. My guess is Spain or Portugal steps up.

In that sense, the Greece debt crisis is a kind of "prisoner's dilemma."

If you're not familiar with the term, the prisoner's dilemma is an exercise in game theory created in the 1950s by Merrill Flood and Melvin Dresher while working at RAND.

The premise, in a nutshell, is that the desire for a greater reward will cause a prisoner to choose to abandon cooperation with a fellow prisoner - even though cooperation is in the mutual interest of both.

Here's the scenario: Two gang members are brought in to a jail and separated...

Each is given the same choice of either testifying against his fellow gang member to gain his freedom or cooperating with him by remaining silent.

If Prisoner A betrays Prisoner B, he goes free while Prisoner B gets three years. If both prisoners stay silent, they both get one year. If they betray each other, they both get two years.

What the exercise shows is that ultimately they will betray one another because the stakes become so high that the benefits of betrayal outweigh the benefits of mutual cooperation.

Interestingly, studies show it doesn't matter whether the game is a single-shot variant or one played over multiple cycles. The outcome is always the same.

Sooner or later one prisoner decides the benefits of going it alone outweigh those of standing with the other "prisoners."

I believe that this is what Europe's ministers really fear, especially when the "tab" just went up.

Think about it... Greece missed the opportunity to declare a strategic bankruptcy on only €300 billion. The next time around it'll be €350 billion or more... counting the current bailout.

Until the EU addresses the now-apparent need for a Grexit, the Greek debt crisis will continue as a series of managed emergencies that lurch from one set of "fixes" to another. Ironically, the cost goes up each time.

Stay Prepared for the Next Episode of the Greek Debt Crisis

Don't make the mistake of confusing monetary intervention with risk management. Instead, take the high road and steer clear of the political wreckage.

The market relief over the near-miss Grexit won't last. When the mayhem resumes, be sure you:

  • Look for Openings in Must-Have Companies: Every new bit of posturing and counter posturing is going to produce market angst accompanied by panicked selling by the weak money. That means some great companies are going to be on "sale" as part of a short-term move that has nothing to do with longer-term potential and upside. So get your buy list ready. The best companies will be those like Becton, Dickinson and Co. (NYSE: BDX), Apple Inc. (Nasdaq: AAPL), and Raytheon Co. (NYSE: RTN) - all of which are tapped into Unstoppable Trends and trillions of dollars in spending down the line.
  • Don't Tighten Trailing Stops: I know this is counterintuitive, but the last thing you want to do is tighten trailing stops on a day when the markets are already pitching a fit. That's because professional traders will "run the stops," meaning they will hunt down the weak money players and force you out of the game very deliberately. That way they can turn stocks on a dime while being perfectly positioned for an upside run. They know that you'll chase 'em, which only adds to their To be clear, I am not saying that you abandon your stops. Just don't tighten them based on emotion or some sort of knee-jerk reaction when volatility rises.
  • Remember That a Correction Is No Excuse to Time the Markets: DALBAR research suggests that 81% of Buy/Sell decisions based on market timing are wrong. That means, to be perfectly blunt, you'd have better luck flipping a coin. Instead, capitalize on big down days and market chaos by using the opportunity to dollar-cost average into positions you want. That means setting aside a fixed amount of capital every month and investing it at regularly timed intervals regardless of market conditions. Doing so not only helps you avoid things like the Greek debt crisis, but also helps you harness the overwhelming upward bias that markets have shown for more than a century.
The Bottom Line: The latest "fix" for the Greek debt crisis fixes nothing. What's needed is a Grexit, although EU leaders fear the domino effect of exits that would follow. What we do know is that this Greek tragedy will have at least one more encore, so investors need to stay prepared.

Follow Keith Fitz-Gerald on Twitter @KFGTotalWealth.

Keith on China: While the threat of a Grexit had investors distracted, the Chinese stock market was plummeting 30%. While most pundits are wringing their hands, Keith Fitz-Gerald has a different point of view - one earned from decades of closely following the Asian giant. Here are five realities that put China's market rout in perspective...

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