The Independent Market Observer

Greek Exit from the Eurozone Looms

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Apr 20, 2015 3:16:39 PM

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greek fiscal cliffNot that long ago, the U.S. was facing a fiscal cliff, with the government at risk of running out of money and the world expected to end shortly thereafter. It was a big deal at the time—mitigated by the fact that the only real problem was the inability of the U.S. Congress to agree.

The problem was political, not economic. As such, it was easily solved with a series of compromises.

I mention the fiscal cliff because it provides some useful context for analyzing the pending Greek crisis. Yes, it’s back again, but this time we really are close to the end of the road, one way or another. Unlike the U.S. fiscal cliff, which was an easily resolved internal political matter, the Greek situation will be much more difficult to reconcile.

A look at both sides

Politics and economics are combining to make any economic solution politically infeasible and any political solution economically infeasible.

The Greek stance: Greece argues that it cannot pay back the money it has borrowed. The European Union sacrificed Greek interests (and those of others) in favor of saving the banking system during the crisis. Since then, no real progress has been made. Greece has been in a depression and will remain there without debt relief. The Greeks have had enough. 

The European stance: As the EU sees it, the Greeks borrowed the money voluntarily, and they lied to get into the euro in the first place. The Greeks have made no good-faith effort to solve the problem. (Note that they’re paying less than other countries have successfully paid.) Without a real effort from Greece’s government, why should the eurozone throw good money after bad?

A tricky political matter

Economically, a mix of debt forgiveness and higher tax collections and payments by the Greeks could solve the problem. Politically, both sides are committed to a narrative that paints the other team as the bad guy, making compromise even harder.

The reason this matters now is that Greece is running out of money and will soon have to decide whom to pay—and whom to default on. Again, the echoes of the U.S. fiscal cliff are clear, but the ease of the ultimate U.S. solution—a simple agreement—isn’t possible here. Instead of two actors, in one country with one tax system and currency, there are multiple players. Instead of one set of taxpayers, there are many. 

The Greek economic situation is getting desperate, and desperate people are not necessarily rational. The Germans, in particular, are getting angrier and angrier—and angry people aren’t necessarily rational, either. The base case now is that Greece will, in fact, leave the euro.

How messy would a Greek exit be?

For Greece, it could be catastrophic, at least in the short term. Whether continued austerity—which the Germans would describe as living within your means—is less painful than an exit is what the Greek government is considering right now.

For Europe, while the damage would probably be contained, it would be an incredibly expensive political failure, with echoing effects for the next several years at least. This could be the biggest geopolitical event of 2015, and possibly of the decade.

For the U.S., though, the effects should be relatively minor. Ours is a fairly closed economy, and we’re already dealing with a slow economy in the rest of the world. Barring systemic effects, for which we are much better prepared than we were in the crisis, any damage will be limited. In fact, we might end up benefiting, as the U.S. is once again seen as an island of political and economic stability—at least compared with the rest of the world.

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