Today’s Headlines: Could a “Grexit” Sink the Euro?

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Today’s Headlines: Could a “Grexit” Sink the Euro?
March 17, 2017

Greek Financial Crisis Rages On

Worldwide financial markets are waiting to see how the new Greek government manages to negotiate a suitable repayment plan for their financial bailout while maintaining the promises that got them elected — or if they can manage the feat at all.

Greek Prime Minister Alexis Tsipras scored a minor victory shortly after taking office by extracting a four-month extension to the Greek bailout program. Since then, Tsipras has found negotiations difficult and is realizing that he realistically cannot follow through on his election promises.

Tsipras and his Syriza party were elected on the promise of renegotiating the Greek bailout terms and replacing austerity programs with spending stimulus. However, in negotiating with the so-called “troika” of primary creditors — the International Money Fund (IMF), the European Central Bank (ECB) and the European Commission (EC) — Tsipras found that he has few cards to play.

Thus, concerns are rising that a Greek exit from the Eurozone (“Grexit”) is actually possible, since Tsipras must thread the needle of finding a compromise that is acceptable to lenders yet has enough support to pass the Greek Parliament for approval.

Rising Tensions Between Greece and Germany

Greece’s total national debt is close to €445 billion, with €246 billion of that owed to the troika via bailout loans. Germany provided €56 billion, or 27% of the total bailout — more than the IMF and ECB combined. As a result, Germany casts a large shadow over the proceedings, and the Germans are growing increasingly impatient with Greek demands for debt reduction.

The escalating tensions between Germany and Greece threaten to take over the proceedings, with clear animosity between the Greek finance minister Yanis Varoufakis and his German counterpart Wolfgang Schäuble. Schäuble was quoted in a recent interview, implying that Greek leaders must point out to the Greek people the underlying cause of the problems, “…that Greece lived beyond its means for a long time.”

Meanwhile, strange and seemingly desperate talk is coming from the Greeks. Tsipras revived talk of an estimated €30 billion in World War II reparations allegedly owed by Germany to Greece, and Greek defense minister Panos Kammenos threatened to send thousands of illegal African migrants to Berlin if Germany does not support Greece’s position in the debt discussions.

German leaders are having none of this, and the German people are beginning to follow. According to a poll from the Mannheim Research Group, 82% of Germans believe that the Syriza party will not carry out their reform promises, and 52% of Germans want Greece to leave the Eurozone. Greeks still overwhelmingly support Syriza (88% in a recent survey) but 69.6% support the government seeking an “honorable compromise” that keeps them in the Eurozone.

That compromise may include extensions of terms, but it is unlikely to include outright debt reduction. The ECB is legally unable to provide any debt relief, and even defaulted countries end up paying the IMF in full. Meanwhile, approximately €7.5 billion in debt repayment and associated costs are due in March, and Greece simply does not have the funds without dipping into pensions and social security funds.

Greece: Can’t Live With ‘Em, Can’t Live Without ‘Em

European leaders and finance ministers are stuck in an equally difficult position. Should Greece pull out voluntarily, or be forced from the Euro for failure to meet obligations, other countries facing serious difficulties — such as Italy, Portugal and Spain — may also consider abandoning the Euro. Some European leaders worry Greece could be the thread that, once pulled, eventually unravels the Eurozone. Conversely, too many concessions to the Greeks may convince other troubled countries to follow with unsustainable demands.

There is still considerable motivation for the Eurozone to accommodate Greece. One major reason is that no one knows precisely how an exit from the Eurozone would unfold — as there was no legal exit mechanism created.

Similarly, it is difficult to predict the likely ramifications of such a departure. What would happen if the Grexit took place? European banks have lowered their exposure to Greece’s finances by over 75% over the last three years, so the direct effect on the banking system would be softened. In addition, no major country is so dependent on Greek trade that their economy would be devastated by a Grexit and any subsequent default. Nevertheless, a default by Greece on nearly one-half trillion euros of sovereign debt would deal a serious blow to the already precarious European economic recovery.

An added concern is “financial contagion” spreading through the Eurozone. The Euro would likely suffer as a currency based on a newfound sense of risk. The short-term effect of removing the Greek debt could be countered and surpassed by long-term stability concerns, with the flames fanned every time a country approaches a bailout condition. The ECB could become so burdened as to impose capital controls.

Such contagion, according to analysts at Oxford Economics, could lower Eurozone GDP by 2.2% through the end of 2016.

The Takeaway

Is Tsipras’ government merely placating the Greek public by blaming outsiders for Greece’s problems? Or is he truly hoping to negotiate a better deal using the only bargaining chip he has — the threat of leaving the Eurozone by choice, or defaulting on his nation’s obligations?

The answer is uncertain, but calming words were spoken by Greek finance minister Varoufakis Sunday night when he said on German public television, “Our intention is to do everything possible to pay back every single euro. My message to your viewers is very simple: help us to grow, so that we can pay the money back.”

In the end, we believe Greece is likely to extract some compromise from the Eurozone despite the objections of Germany, and that the Eurozone will continue as is. Cooler heads are likely to prevail in this round. However, if significant concessions were awarded to Greece, it would place added pressure on the ECB at a time the central bank is rolling out its own stimulus program. Very unwelcome timing, indeed.

Given the overall trend of the Euro, you probably have been avoiding it anyway — but until it is clearer how the Greek crisis will resolve itself, it makes sense to reconsider your risk with exposure to the Euro and Euro-backed investments. Consider rebalancing your portfolio using new definitions of Eurozone risk.

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