The latest story with the struggling country is the possibility of a “Grexit,” or Greek exit from the euro zone. There is still much uncertainty surrounding the issue and how serious the possibility is.
On May 6, Greece held elections for Parliament that resulted in an even divide between pro-bailout and anti-bailout parties. Polls show support for the opposing parties to be almost dead even, suggesting that the new vote on June 17 will be a close and significant one. A large majority of Greek people want to stay with the euro, but are sick of having their livelihoods negatively affected by the austerity conditions set forth by the EU and IMF.
The 2 Sides
The radical leftist Syriza party, led by the young Alexis Tripras, has appealed to followers with the sentiment that Greece would never actually be kicked out of the euro because of the impact it would have on other surrounding fragile economies. The party is therefore against the Greek bailout and the policies set in place along with it. The party has garnered support from younger generations who have known nothing but unemployment since entering the able work force.
The New Democracy party represents the pro-bailout side of the issue. They are looking for support mainly from more traditional voters by threatening that Greece will be forced to leave the euro if left in the hands of Tripras and the anti-bailout left.
What if Greece Leaves?
There are very legitimate concerns about whether the euro zone could survive a Greek exit, in terms of the possible shocks that could emanate throughout the rest of the zone, especially with fears of other exits to follow.
However, there is a school of thought among many officials that unlike a couple of years ago, the contagion could actually be controlled today. The firewall of resources to protect the euro zone in the event of catastrophe makes the potential exit more manageable. There is a 500 billion euro rescue fund that would help to act as a buffer to the initial shock.
Generally, most worries surround the fate of Europe’s banks, and how individuals will react to seeing money in euros turned into drachmas—in other words, they may scurry to place their money in other European banks they perceive to be more stable and reliable, damaging much of Europe’s banking system.
Greece itself stands to lose the most, and in our opinion, substantially more than any other countries who will be affected by what occurs there in the months to come. If Greece were to exit the euro zone, the new drachma, to replace the euro, would probably depreciate at least 30%. Although such depreciation would eventually attract money into the country, it would not come without large detriments to the Greek people holding tremendously devalued currency. In fact, it would require a very focused and dedicated Greek government to rebuild a banking system and convince its people to stick out an undetermined time period of lower living standards during strict austerity measures.
In the Event of Default
In reality, it is probable that regardless of whether Greece leaves, the country is headed towards worse days. It will most likely come down to an issue of default—it is merely unclear whether the default will happen with Greece a member of the euro zone or not. It is unlikely that the other euro zone members would ever force Greece out (there would be far too much political reverberation for this), so it will ultimately be Greece’s decision, and in particular, the leadership of the country, to be determined in mid June.
Default is clearly a dangerous thing for European banks. However, the move by the European Central Bank at the end of last year to agree to pump liquidity into European banks was done with this very prospect in mind. In that regard, banks have already been shielded against contagion to some degree. This is the one great defense still held by the euro zone, and it is surely a powerful one. The ECB has the ability to expand its balance sheet and buy up the country’s bad debt ferociously, providing unlimited liquidity to those banks facing runs. Even anti-inflationary Germany, led by Chancellor Merkel, made mention of a willingness to help with such an initiative. The support of stable and financially sound countries like Germany is key to the zone’s ability to emerge from a potential default crisis.
Howe & Rusling’s Stance
Thankfully, in the event of a default, while certainly traumatic and impactful to Europe’s economy as a whole, we believe that Greece is small enough to not cause catastrophe on a global scale.
We are confident in the ECB’s ability to act quickly and efficiently, should this situation arise. Our investment team is prudently considering our exposure to Europe, and will make changes as we see fit. We remain confident in the growth of our domestic economy, and this is reflected in our current portfolio allocations.
© 2017 Howe and Rusling, Inc.