Global Glimpse Report

A Fall from Greece

You’ll have to forgive the pun. Greece really has fallen a long way in the last few years. Just in the past couple of days, I’ve seen headlines suggesting a deal between Greece and its creditors was close only to see another headline to the contrary, like an international high-stakes game of “Deal or No Deal”. As news of a potential Grexit (financial-speak for a Greek exit from the Eurozone) continues to make headlines and since a few clients have asked me recently why Greece continues to cause so many problems in the world economy, I thought I’d offer some thoughts.

Why are we talking about Greece and not Portugal or Ireland or Spain? We’re talking about Greece because, in simple terms, the Greek government borrowed a lot more than most other Eurozone nations, didn’t do anything productive with that money and then couldn’t (or wouldn’t, depending on your perspective) pay their bills.

How did this happen? When the European Monetary Union was formed, bond investors began to assume that all European government debt was the same. After all, it was one currency union with one central bank, just like the United States. And since Greek debt paid more than German or French debt, investors bought a lot of it, assuming creditworthiness wasn’t an issue. This drove down the yields (i.e. the interest rate) Greece had to pay on its bonds, making it cheaper and cheaper to borrow more and more money, very much the opposite of how most countries and households operate. If it’s cheaper to borrow, it’s cheaper to spend. And politicians love to spend. If there aren’t any taxes hikes to pay for increased benefits and services, all the better. It’s all free money, or so it seems.

But then came the credit crunch and the deep crack in the Eurozone was revealed. It became very obvious, very quickly, that Greece had next to no hope of ever paying all their creditors back in full. Unlike the United States, where if Delaware or Louisiana were to default on their debt the federal government would step in to foot the bill, nobody was quite sure what would happen if Greece defaulted. Creditors were treating Greece like a member of a well-known family. He comes from a good family, so he must be good for it, right? And if he’s not, then certainly one of his relatives is. But what if the family recently had a falling out and doesn’t want to cover their delinquent cousin’s debt when he defaults? The lender is left holding the bag.

That takes care of how Greece took on so much debt. But Portugal had a lot of debt, as did Spain and Ireland. Why is Greece so different? There are a number of quantitative factors that are at play, but those don’t tell the whole story. For the most part, there was a large deficiency of political courage in Greece and the Greek government simply did not want to pay the piper. Leaders in Portugal, Spain and Ireland stepped up to the plate and told unhappy voters what needed to be done whereas this never happened in Greece and the wound was left to fester. After realizing they were truly out of options the Greek government began to capitulate to austerity, but because their government had failed them so miserably Greece’s delayed austerity was even more punishing than the rest of the Eurozone. Blaming Germany, the European Central Bank and the International Monetary Fund instead of their elected officials, elections were held.

Enter Alexis Tsipras, the man who has been playing chicken with the world economy. Seeing a path to power, Mr. Tsipras promised the Greek people a future without austerity and simultaneously promised the world Greece would remain in the Eurozone. Quickly after taking office, Mr. Tsipras realized the gravity of the Greek situation and was stuck between a rock (angry Eurozone officials and lenders) and a hard place (angry voters when you’ve promised what you can’t fully deliver).  But he also knew how destructive a Grexit would be to the Eurozone and to the global economy. Since that time, he has held the world hostage by demanding large write-downs of Greece’s debt. As Bob Dylan said, “When you ain’t got nothing, you got nothing to lose.” This very dangerous game has caused markets to doubt the integrity of the entire Eurozone. The rest of the Eurozone, especially the other indebted nations who had taken their painful medicine, understandably balked at this brash young man (who famously never wears ties to meet world leaders) dictating terms to them, the lenders of relief funds, about how things would go.

So where do we go from here?  The fact that the on-again-off-again relationship between Tsipras and Eurozone representatives hasn’t rattled markets dramatically would suggest that many believe a deal is inevitable and baked in the cake. But just because you don’t think a train will come around the bend in the near future doesn’t mean it’s wise to take a nap on the tracks. As always, when thinking about risk we must expect the probable but also be cognizant of the improbable (especially if that improbability would lead to drastic consequences) because even if that event doesn’t happen, that doesn’t make the decision to flirt with its occurrence any wiser.

With both parties playing hardball, the real risk now is that even though a deal is still likely (because trudging along in an imperfect system is still far better for both Greece and the Eurozone than a very messy breakup), every day a deal isn’t struck leads to more uncertainty and a greater chance for miscalculation on either side. While we believe a deal will be struck, we will likely see continued volatility fueled by a lack of clarity as to the direction of the talks.

The bottom line is that the Eurozone needs to retain Greece in the monetary union, not because Greece is an important economy or that a Grexit would cause fundamental economic pain to the other Eurozone countries, but because a Grexit would signal to the world that the European Monetary Union is a misnomer. If a country can choose to leave a monetary union, it isn’t a monetary union at all but rather a fixed-peg currency exchange system. This would be roughly similar to the ramifications of the first legal divorce. Marriage immediately went from “until death do us part” to “I might have some other options.” This is the crisis of confidence and perception the Eurozone is so desperately trying to avoid.

We believe the Eurozone will continue to do what they’ve so successfully done up until this point: kick the can down the road. Until then, I don’t think I’m alone in hoping that Greece once again becomes ancient history.
Best regards,

Patrick R. McDowell