Why Greece Matters

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jun 25, 2015 12:25:00 PM

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GreeceThe topic of the day, once more, is Greece. Frankly, I’m sick of writing about Greece, and I’m sure everyone involved in the negotiations, including the Greeks, is even more tired of the whole thing than I am.

Here's the question: Why do we all continue to bother? What makes Greece worthy of such continued attention?

It certainly isn’t its size or economic importance. Greece’s economy accounts for slightly more than 1 percent of the European Union as a whole (1.29 percent in 2014). On a global basis, Greece is even smaller, as are all of the European countries. Indeed, this was one of the major reasons the EU was formed—to allow smaller countries to act with greater impact.

From an economic point of view, Greece simply isn’t big enough to matter. Rather, it’s important for two noneconomic reasons: the systemic risk it represents today, and what the outcome of the crisis could mean for Europe’s future.

Greece today: another Lehman Brothers?

You might compare Greece with Lehman Brothers, the firm that triggered the 2008 financial crisis. In and of itself, Lehman, like Greece, wasn’t big enough to worry about; larger firms have collapsed before and since with no systemic effects. The trouble was the connections between Lehman and other firms, which caused Lehman’s collapse to shake the system as a whole. The fear is that we might see something similar in the event of a Greek default.

We probably won’t. Unlike with Lehman, everyone sees this one coming, and European regulators and governments have been building firewalls for years. The better comparison (hopefully) is with Y2K, where wide knowledge of a pending problem enabled everyone to prepare, so that in the end there was no problem.

Another helpful factor is that very little Greek debt is now held by private entities; most is with public institutions, which are less constrained by market forces. Probably won’t is not certainly won’t, however, and that is what’s rattling the markets. Nonetheless, despite short-term volatility, the longer-term economic damage should be limited.

Greece tomorrow: a signpost for Europe

There’s another, more important explanation for why Greece matters. In Europe, it’s the poster child for countries that want to spend more than they bring in, making up the difference with borrowing until they default—and then do it all over again. The conflict is between a eurozone designed on German lines, which specifically prohibits this behavior, and the Greeks’ desire to do what they want.

Greece is the test case for whether a country can be forced into a mold that doesn’t fit. The answer seems to be no.

Other countries are watching closely. Spain and Italy are trying to fit into the German model, but not with any real enthusiasm. The conflicts that are slowly strangling Greece due to its refusal to change are working in those countries as well, albeit more slowly. What happens to Greece is very likely to happen to other, more systemically important countries at some point in the not-too-distant future.

How the Greek crisis is resolved will guide the options available to Spain, Italy, and, ultimately, France. And if you consider the collective size of those countries, the outcome could shape the future of Europe itself. If Greece is forced out, a major segment of Europe will have to change dramatically if the Greek exit isn’t to become the first of several.

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