For some months there has been speculation among senior government and corporate figures as to whether Greece will default on its unsustainable commitment and leave the European Union and common currency area either by choice or by force.
Today, this is no longer a matter for speculation as the likelihood of such an event is being bolstered by the veritable masses of investors emptying ATMs across Greece following Prime Minister Alexis Tsipras’s announcement on Friday of a July 5 referendum on austerity measures demanded by the country’s creditors.
The earlier this year sent a clear signal to the European Commission that Greece’s electorate takes a dim view toward potential austerity measures, and that a will to work hard toward paying off the swingeing debts that the country has amassed is either scant or non-existent.
Greece, a country with a population of only 11 million, has been the subject of several high-value bailouts during the course of the last five years. When examining the situation closely. it is clear that it is unsustainable. The European Central Bank’s capitalization is approximately EUR 340 billion, and the loan extended to Greece, a nation which has a small population and very low productivity, amounted to EUR 190 billion, over a third of the entire capitalization of the European Central Bank, using Greek banks as collateral.
As senior economists among some of the world’s largest financial services companies now predict that the end is nigh, the Euro fell 2% against the US dollar over the weekend, and is now standing at 1.10 representing a low point first reached after the election of Mr. Tsipras.
Mohamed El-Erian, Chief Economic Adviser at insurance and financial services giant Allianz SE (FRA:ALV) is one senior executive who considers an exit from the European Union by Greece to be very likely. ““There’s an 85 percent probability that Greece will be forced to leave the euro zone in the next few weeks” Mr El-Erian said in an interview with Bloomberg in New York.
“What we are seeing here is what economists call the sudden stop, when the payment system stops. The logic of a sudden stop is a massive economic contraction, social unrest and it’s going to make continued membership of the euro zone very difficult for Greece” he continued.
“This has been an accident in the making for a number of years,” said Mr. El-Erian. “It reflects an inability to understand each other’s point of view and an inability to compromise. Europe should have been much more forthcoming on debt reduction and Greece should have been much more forthcoming on implementing reforms.”
Mr. El-Erian concluded that the European Central Bank will be a key player in trying to contain fallout across the region as the crisis threatens to undo much of the work that President Mario Draghi has done to shore up confidence in the euro as a leading currency of global trade.
Whilst the possible exit from the Eurozone by Greece may eventually be a boon for productive nations which are supporting it in the long term, the burden being removed and the metaphorical black hole no longer present, the initial effect on the continental European economy will be reasonably grave as the non-repayment of such a large percentage of the European Central Bank’s capital is not something to be taken lightly.
Capital controls and bank closures
One thing that can most certainly be learned from history is that once bank closures and capital controls are put in place, investors run for the hills, often with however much of their money that they can get their hands on.
Argentina imposed capital control laws in 2011 in order to stem dollar flow, the result being a vast upsurge in black market US dollars and a 30% price premium for Bitcoin, whilst confidence in the nation’s inflationary Peso declined to negligible levels.
Public sentiment in Greece reflects this quite accurately. “People are feeling very concerned … very insecure,” said Maria Poulimeniou, outside the National Bank on Eleftherios Venizelos street in Kallithea, a southern Athens suburb. “The situation changes from one minute to the next. First they say the banks will be closed on Monday, now for the whole week.”
Ms Pouleminou, who works in the finance department of a shipping company, said she had tried the local branch of her bank, Alpha, but “they had nothing left. Empty. So I’m here. I’m taking out the limit which at the moment is €600, but they say after midnight it will be €60. That’s why there’s a line.”
Sam Tuck, a senior currency strategist at ANZ Bank New Zealand Ltd, has told Bloomberg that we’re entering a “very very volatile” time.
“The knee-jerk reaction is for flight out of the euro and into safety. Defaulting to the IMF tomorrow looks like a certainty and when that happens there is no proposal, there is no legal mandate for Europe to bail out Greece. There are a whole bunch of unknown unknowns” he said.
Uncertainty is at its highest yet
The vast differential between productive European Union member states with good economies – namely Britain for its advanced financial sector and Germany for its traditional (but long term unsustainable) manufacturing sector, and the endebted, socialist nations with strong allegiance toward the European Commission and IMF reliance is apparent.
France, a country with a 30 hour working week, no financial sector and a debt to GDP ratio of 250%, takes a very different view to that of many commercial economists. President Manuel Valls urged the Greek authorities to “come back to the negotiating table” after Athens broke off deadlocked talks on trying to rescue Greece’s debt-stricken economy.
President Valls refused to attack the decision of the Greek government to call a referendum, saying: “When you ask the people to decide, to exercise their democratic right, this should not be criticised.
“It is obvious that if there is a negative response, there is a real risk … of leaving the eurozone,” Mr. Valls told rolling news channel iTELE.
“I continue to believe that a deal is still possible and I invite the Greek government to return to the negotiating table,” the prime minister added.
Learning from history is one vital piece method of ensuring that the same mistakes are not made several times over, however future-proofing is even better.
The British victory over the European Commission’s proposal to forcibly relocate Britain’s institutional electronic trading center including FX and clearing entities from London to the European mainland which not only faces financial ruin but has no electronic trading sector whatsoever, was indeed a victory to be lauded.
EURUSD chart courtesy of Google Finance, Photographs courtesy of MoneyWeek and Bloomberg