15th May 2012
The media narrative has been that Greece's exit would prompt everything from civil unrest to the collapse of Spain. But markets and media alike thrive on drama. What if the Greek exit from the Eurozone is not a crisis? Could its exit, in fact, help solve the Eurozone crisis?
A number of arguments have been made as to why a Greek exit from the Eurozone would be a disaster:
1) Civil unrest – Greek savers would suddenly find themselves with Drachma-denominated savings, worth a fraction of their Euro-denominated savings. This, it is argued, would prompt rioting and civil disobedience on a grand scale.
2) Contagion – From UK business secretary Vince Cable to ECB President Mario Draghi, policymakers have warned about the dire effects of contagion to other weaker European countries – Portugal, Spain, Italy and Ireland. As CornishWrecker argues on the FT community boards: "A Greek exit and debt default will cause incalculable political damage to not only the eurozone but also the EU. It also will encourage a much larger and more damaging Spanish exit and debt default, a default that the ECB and the EU cannot afford."
3) The mechanics are extremely difficult – On the BBC, Robert Peston says: "Any business of any nationality will find it extremely difficult to leave its money in euros in a bank in a country perceived to be at risk of following Greece out the door. That risk was already highlighted earlier this year in public statements of Vodafone, GlaxoSmithKline, WPP and Reckitt Benckiser that they were moving their surplus cash out of euros and out of the eurozone on a daily basis. – banks in the vulnerable economies finding it increasingly hard to hang on to deposits and increasingly hard to borrow." It may re-establish the link between the Eurozone sovereign debt crisis and the banking sector, so assiduously severed by the LTRO.
4) The hit to the German and other Eurozone economies from losses on Greek assets – Peston adds: "As of March of this year, the German central bank had 644bn euros of claims on other central banks, equivalent to a quarter of German GDP. These are euros owed to the Bundesbank by the central banks of the economies where there has been the greatest capital flight, names those of Greece, Italy and Spain. So if all of a sudden, Greece and Italy and Spain decided to revert to their national currencies, it is an interesting question how much (if any) of the 644bn euros the Bundesbank could get back."
But there are plenty who believe a Greek exit will be beneficial for the Eurozone as a whole. Tim Guinness, Energy investment specialist at Guinness Asset Managers for example, says: "Bring on the day that Greece finally bites the bullet and leaves the Euro. I think everyone will breathe a sigh of relief and we can start getting on with life as normal. I think you'll see a good bounce in markets within ten days of that happening;"
With each of these arguments, it is worth asking the question: Which is more painful? Civil unrest is undoubtedly an issue, but are people more likely to be moved to riot by the devaluation of their savings or the loss of their jobs prompted by the further austerity demanded as a condition of ongoing bailouts?
It is difficult to find anyone who believes contagion will not happen. Contagion is consensus. Take the catastrophic pronouncements of this West LB economist here: "There is a good chance that the market would immediately trade Portugal towards pre-debt swap Greece levels. The next in line would certainly be Ireland and Spain.
"Initially you have got to assume that spreads would become even more dislocated. As you are moving out and down the credit curve the ones with the weakest credit ratings will likely suffer worst, at least initially, because we are moving clearly into the world of the unknown and that's precisely what the market doesn't like."
Yet figures as powerful as the German Finance Minister have suggested that there are mechanisms in place to prevent the exit of Greece having broader repercussion: Wolfgang Schaeuble was been quoted in the Rheinische Post newspaper: "We have learned a lot in the last two years and built in protective mechanisms…The risks of contagion for other countries of the eurozone have been reduced and the euro zone as a whole has become more resistant. The notion
that we wouldn't be able to react in a short time to something unforeseen is wrong."
What do the fund managers think?
In this piece, all the fund managers interviewed believed that steps had been taken to manage contagion and that it remained an unlikely outcome of a Greek exit.
Therefore, it is a risk, but one well-established in the minds of policymakers. This Economist piece argues cogently the steps Eurozone politicians could take to prevent contagion, including, for example, a credible commitment to mutualise the debts of remaining euro-zone countries or an extension of the current programmes for Portugal and Ireland and/or a reduction in interest rates charged by their official creditors.
This leads onto point 3 above. If contagion were removed as a risk factor, companies would have faith in the currency. Also, it is not as if Greek's potential exit from the Eurozone and therefore the vulnerability of the Euro has not been known for some time. It also impacts on point 4 – if contagion were prevented, German banks would take a hit on Greek assets, but may not have to take any further losses from the rest of Europe.
A Greek exit exposes the Eurozone to many risks. However, as this chart shows – the situation in Greece is substantially worse than any other European country so to assume contagion is not rational. Greece's exit may be a disaster. On the other hand, it may be just the tonic the Eurozone needs.
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