The Independent Market Observer

Why Greece Really Matters

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on May 12, 2015 12:26:00 PM

and tagged In the News

Leave a comment

GreeceAs promised yesterday, I want to talk about how the Greek situation could end up disrupting Europe and the European financial system, but in a completely different way than most people expect.

The possibilities for Greece

I see three different directions the Greek situation could go.

Things continue pretty much the way they are now. Additional aid trickles in, but just enough to prevent complete collapse and not enough to allow Greece to recover. This is where we’ve been for the past several years, and it now seems the least likely outcome, as the Greeks, the Germans, and everyone else have completely lost patience with the process and with each other.

A comprehensive settlement, including debt forgiveness, is put in place in exchange for real, thorough Greek governmental and financial reforms. I won’t rule this out—although more from hope than from conviction—as it would represent the best solution for everyone. But with the politics becoming more stressed by the day, it’s not the most probable scenario, in my opinion.

Greece defaults on its debt and leaves the euro. Unfortunately, this outcome looks the most likely. We’ve talked about the possible systemic consequences of a Greek exit before, but consider the effects on the country itself. Greece would have to reintroduce the drachma, renegotiate or repudiate all existing debt, find ways to pay for necessary imports—the list goes on and on. In any event, the short-term consequences would be dramatic and disruptive.

Longer-term, things could get interesting

If Greece leaves the euro, it will either recover or continue to sink. Sinking is self-explanatory, but a recovery is both possible and reasonable. Once Greece defaults, it acquires several significant advantages. Debt payments go away, at least until a settlement is reached. The new currency, the drachma, is much cheaper than the euro, giving Greece a real cost advantage against eurozone countries.

This, in fact, would be a repeat of the strategy Greece and other Mediterranean countries have used, very successfully, over the past couple of centuries: load up with debt, default, and devalue. The problem those countries face under the euro is that they can’t do the second and third steps. By leaving the euro, Greece can default, devalue, and reasonably expect to recover, just as it’s done in the past.

This is exactly how the euro could fail. If Greece exits and then recovers strongly with a cheaper currency and less debt, the other indebted countries will look around and think “Why not us?” In particular, Italy and Spain, which historically have done the default and devalue dance, have struggled to grow under the euro’s discipline. Should Greece leave and prosper, average voters in the other countries are bound to become even more reluctant to continue suffering than they are now.

What’s worse: Greek success or Greek failure?

Most of the concern about Greece’s debt crisis centers on the potential costs of a Greek exit and failure. In my opinion, the real risk of euro failure comes from a successful Greek exit. Either way, there's no reasonable path that brings the euro back as a central currency, and its appeal stands to take a serious hit. 

                      Subscribe to the Independent Market Observer            

Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®