01 Jul The European Merry Go Round

The European Merry Go Round

Greece & the “Troika” of the European Commission (EC) European Central Bank (ECB) & the International Monetary Fund (IMF) continue their “sabre rattling” with various proposals suggested and rebuffed by both sides. The issue for Greece is what deal do they want to take, as neither is good for the nation in the short term. At present Greece has not paid the IMF it s agreed loan repayment (which for example would be similar to someone here not paying their monthly home loan or personal loan instalment).

The long-term damage may yet be minimal. If Greece is only in arrears to the IMF for a short period of time, the IMF may be shown leniency down the line. The IMF’s policy does distinguish between short-term and long term arrears.

This is not yet a full-blown sovereign debt default by Greece. This is still a first for an EU member state, but the IMF is keen to maintain a distinction between a country being “in arrears” and a “default”. This distinction is also made by credit rating agencies (Moodies, etc.) It means the consequences for Greece may be temporary and small, if they are able to find a speedy resolution and make the payment.

Being in arrears to the IMF is not a new phenomenon. Since 1997, arrears owed to the IMF that were at least six months overdue have ranged from 1.5 bn to 3 bn euros per month. It does however place Greece in the company of countries whose governments who would not be seen as great economic managers. These countries with IMF repayments at least six months overdue in the past decade are Liberia, Somalia, Sudan & Zimbabwe.

The reality is that Greece is broke (and should have never been allowed into the Euro in the first place) but needs the ECB to provide funding so that their financial system can operate properly & have sufficient liquidity. Personally (for what it is worth and I don’t know better than the next person) I believe that a deal will be cut at the 11th hour 59th minute & 59th second. For Greece to exit the Euro system will cause them far more much pain as it will likely plunge the country into a depression. Don’t be surprised if you see the Americans ride in on their White Horse to save the day. They have been unusually quiet on this issue, but I am sure that they have been very busy in the back channel area & may become more involved both politically & economically over the next period.

What Does it Mean For The World Economy as a Whole & Investment Markets ?

Greece has a population of 11 million people and it’s economy represents only 0.3% of world economic growth (GDP) – which is less than the size of say either Romania or Peru as an example. It’s direct trade links to the Eurozone (excluding Cyprus) represent only 0.5% of the euro area exports (remember Cyprus has a population of only 850,000 – smaller than Adelaide).

Greece relies heavily on imports. Its top 3 are pharmaceuticals, crude oil, and refined petroleum all necessities. While its top export is also refined petroleum, it has to import crude oil for its refineries. Its only major homegrown exports are fresh fish and cotton. It would be hard to significantly increase sales of either product: The European Union has strict quotas to prevent overfishing, while cotton production struggles from fluctuating demand for textiles and a lack of bank financing. It’s other source of revenue is via tourism. Prices have already been cut in Greece & it is their inability to collect taxes given the long standing black economy which crimps their economy as well.

Leaving the Euro (Grexit) would mean that the Greeks would need to reintroduce the drachma (or other such currency) which would be worth probably < 50% of the Euro. Any Greek business which carry debt from European Banks are held in Euros so the value of the debt carried by these businesses would double overnight & the price off pharmaceuticals & petrol would suffer a similar fate.

The Head of the ECB (Super) Mario Draghbi has been on public record previously saying that the ECB would do anything to preserve the Euro. So if there was a Grexit the ECB has sufficient firepower to buy bonds of peripheral countries (Italy, Spain, Portugal, etc.) to hold interest rates down & provide liquidity to the banking system. Most of the Greek debt is held by the official Euro zone via the ECB/IMF, so a default on this debt does not affect the day to day running of financial institutions. Well capitalized European & Global Banks only hold a tiny sliver of Greek debt.

Equity markets have also been relatively sanguine on this matter. Whilst markets are always subject to volatility an ultimate “Grexit,” if it happens, could actually strengthen the euro and calm markets by removing that uncertainty. The ECB has already ring proofed the European monetary system and has detailed above has sufficient monies available to provide liquidity to the peripheral nations.

As we have seen a spanner has been thrown into the works late in the piece with a referendum set down for this weekend. What Does This Mean ?

Referendum Scenarios

In the event of a “yes” vote: You would think that the Greek Prime Minister Alexis Tsipras would resign and a new national unity government to be formed. A new government likely would restart negotiations with the Troika in an attempt to implement a new debt relief proposal. The Emergency Liquidity Assistance (ELA) program now in place presumably would be extended to cover the period of these new negotiations over several weeks or more. Greek Banks would likely remain closed immediately after the referendum until a short term solution can be agreed upon.

In the event of a “no” vote. The ELA would be pulled and the Greek banking system would likely remain closed. If and when banks do re-open they will quickly run out of Euros and would probably begin issuing IOUs that would essentially become the defacto currency of Greece. The European Central Bank (ECB) likely will be aggressive in protect the European monetary union (by buying up bonds of the peripheral nations). The next issue is does this mean the start of the Grexit, or will more negotiations go on.

Whilst the situation remains fluid I am of the mind that more sensible actions will be taken & resolutions reached.