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By Shavasb Bohdjalian
The euro tumbled sharply lower over worries that Greece will default, with the market not impressed by the latest revenue raising measures announced by the government of George Papandreou over the weekend.
Market participants were forced to abandon the euro as news emerged that the ECB’s Chief Economist, Juergen Stark resigned from the ECB’s Governing Council and as reports emerged that German finance minister Wolfgang Schauble has activated “Plan B”, under which German banks and insurance companies have been instructed to prepare for 50% haircuts on Greek debt as Greece is allowed to default.
Once again the Germans are playing with fire since it is not clear how a Greek default will hurt the European banks, which according to a report by the IMF are undercapitalized by EUR 200 bln.
It’s unfortunate that the Greek government once again missed a golden opportunity to put its house in order as it forced the Troika members to leave Greece, and faced with the possibility of not receiving the sixth tranche of the agreed loan, proceeded with a new austerity package, according to which it would introduce a property tax and, in a largely symbolic move, cut the salaries of all elected officials. This may be enough to satisfy the returning 'troika' inspectors this week, but we will have to wait for confirmation if the sixth tranche will be released and if a number of EU members such as Finland, Austria and the Netherlands will participate. In the meantime, media reports suggested that the preliminary responses from bond investors on the proposed debt swap are running at only 70% – below the 90% threshold that Greece said it wants to go through with the deal.
In the event of no take up by private banks of the original plan to shed 21% of their value and if some eurozone nations withhold new loans to Greece, then market participants should seriously consider the repercussions of a Greek default.
Stephane Deo from UBS said in a report that if Greece left the eurozone, the new drachma would crash by 60%. Its banks would collapse. Switching sovereign debt into drachma would be a default, shutting the country out of capital markets. Exit would cost 50% of GDP in the first year.
If creditors such as Germany left, the new mark would jump 40% to 50% against the old euro. Banks would face big haircuts on euro debt, and would need recapitalization. Trade would shrink by a fifth. Exit would cost 20% to 25% of GDP.
Ultimately, political investment in the EU project is by now too great to entertain such thoughts and its obvious that a break will cost both sides enormously. The most likely outcome is for the eurozone to muddle through along a third way, with some sort of debt restructuring in place under which the ECB will be given the mandate to print “unlimited amount of money” to purchase Eurobonds and limit the damage from a Greece default.
After all, if the US Fed can purchase unlimited amounts of US Treasuries and the Swiss can print as much as they wish to devalue the Swiss franc, why not the ECB? Considering that Europe is China’s largest trading partner, the Chinese are also likely to join in a rescue package.
The euro may weaken in the months ahead but EU leaders will not allow the single currency to break up. In most likelihood however, it seems “Plan B” is in motion and it’s now only a matter of time before Greece is allowed to default.
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(Shavasb Bohdjalian is an approved Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, authorized and regulated by CySEC, license #114/10. The views expressed above are personal and do not bind the company and are subject to change without notice. Investing in markets and trading on leverage is highly risky and it may not be suitable to all investors since it carries a high degree of risk and you can lose more than your initial investment)
