Many people are wondering why the Greek economy is having such a major effect on the global markets. Why is such a small country making the world’s major markets rise and fall with every headline that comes out regarding their possible economic collapse? Fear of the unknown is driving the seemingly schizophrenic markets up and down like a yo-yo. When Greek Prime Minister George Papandreou presented the idea of a referendum on the bail out uncertainty and fear grew to a fevered pitch. The masses in Greece did not want to submit to the changes that would be required by the European Central Bank (ECB) for the new bail out loan, but the government believed that without it the economy will totally collapse. There are two major components to this issue. First is the chance of Greece defaulting on the bailout loans that they have already been given. The second has to do with the chance that they could pull out of the Euro as a currency.
When we consider the problems that would occur if Greece defaults, we have to look at how this would affect the lender countries. Large banks in Germany, France and England have propped up Greece with loans. Greece is not an insignificant economy and it’s failure would send ripple effects throughout the world, think “too big to fail”. They are also intricately linked to Greece through the European Union (EU). Many think that if Greece defaults, other members might default as well. The Wall Street Journal stated, “The decision by Greek Prime Minister George Papandreou to shelve the poll capped a tumultuous few days that thrust Athens to the brink of political chaos and forced Europe’s leaders to contemplate Greece’s exit from the single currency.” Source That brings us to the other major issue. Greece might pull out of the Euro as it’s national currency. As the seventeen member nations of the EU consider the possibility of Greece rejecting the euro the fear is that other member nations may also follow suit. This would cause a major destabilization of the remaining EU member’s currency and ultimately their economies.
Some think this is just a problem for the EU, saying, “sure it will impact us but it isn’t really a problem for the United States.” Unfortunately that is not true. Many of the large American banks issued default insurance to the banks that were lending to Greece and other struggling nations. If Greece (et al) default, then these major US banks will have to pay out billions to cover the losses. These are many of the same big banks that were bailed out by the American taxpayer just a short time ago. Their “toxic” debt was graciously passed on because the government deemed them “to big to fail”. Sound familiar? So there is a very good reason for us to keep our eyes on the developments in Greece and other EU countries that are at risk of default. Now, it would seem that we’re tied to their future.
The impending Greek elections will reframe the euro crisis in terms of debt relief. That will force new and adverse scenarios on the region. The repercussions will be global.
Before the New Year, the Hellenic parliament rejected the nominee of Prime Minister Antonis Samaras for president. In accordance with the Greek constitution, a general election will follow on January 25.
Between 2008 and 2015 Greek GDP per capita, adjusted to inflation, tanked from $30,820 to $21,570; that is, 30 percent. After half a decade of misguided austerity policies, the moderate middle has been discredited in Greek politics.
Alexis Tsipras, leader of the radical leftist party Syriza, delivers a speech during a congress of the party in Athens, on January 3, 2015. Syriza.
The conservative New Democracy (ND) is losing its lure. The PASOK social-democrats have shrunk. However, the support of fringe parties has exploded. In current polls, the radical left coalition Syriza garners about 28 percent of the vote, as against 25 percent for the ND, even if this lead has narrowed somewhat.
Led by the young and shrewd Alexis Tsipras, Syriza has played down its radical left-wing left roots and become more populist. It needs mainstream voters to govern.
But what will Syriza do if it wins?
Athens did not return to markets on its own, but after two huge bailouts of €73 billion ($88 billion) and €164 billion ($197 billion), respectively. Behind-the-façade talks have begun over a third bailout amounting to some €20 billion to €30 billion ($24 billion to $36 billion).
By 2012, German Chancellor Angela Merkel was close to permitting a Greek default. But the fear was that if the Greek contagion could not be contained, it could spread to Italy and Spain. As a result, Greece was given its second bailout, but only so that Italy and Spain would be ensured a two-year timeout to stabilize their economic turmoil.
Vowing to challenge half a decade of austerity policies that caused a Depression in Greece, Syriza seeks to expand its constituency by policies that are considered highly controversial in Brussels and Berlin.
These measures include a (big) haircut for creditors; tax cuts for all but the rich; an increase in the minimum wage and pensions to €750 a month; free electricity, food stamps, shelter and health care for those who need it; a moratorium on private debt payments to banks above 20 percent of disposable incomes.
But nothing worries the Troika — the European Commission, European Central Bank (ECB) and the International Monetary Fund (IMF) — more than the Syriza's pledge of an international conference on debt relief, vis-à-vis "official sector involvement" (OSI).
In his meetings with the ECB, Germany's finance minister and IMF executives, Tsipras has said that debt profiling would only involve OSI — a message that his economic advisors have repeated to funds and investors in the City of London.
In 2015, after bailouts that amount to some €250 billion ($300 billion), Greece's current financial needs are estimated at almost €20 billion ($24 billion). These include interest payments, IMF funds repayments, ECB's maturing bonds, and arrears.
External assistance will only come with strings attached. In December, the sixth review of the Greece's bailout program was not completed but extended until the end of February 2015.
Until the election, the IMF, which currently remains the only OSI provider of funds to Greece, and the Hellenic Financial Stability Fund are hedging their bets. The recent widening of the Greek government bond (GGB) spreads indicates that volatility is largely confined to Greece in Europe; at least, for now.
In the past few years, Brussels has managed to build insulation mechanisms to reduce the probability of contagion. Nevertheless, these mechanisms rely on the market expectation the ECB is about to shift to broader quantitative easing (QE).
The ECB's full QE is expected to include purchases of the larger Southern European economies (e.g., Spain and Italy), which are seen as too-big-to-fail — but not necessarily those of smaller peripheral countries (Greece, along with Portugal and Cyprus).
The real drama starts, when Syriza and the Troika will begin their negotiating gamble in the end of January. Tsipras has set the tone by saying that his government would cease to enforce the bail-out demands "from its first day in office."
He is hoping that the Troika and Germany would blink and support Greece, despite Athens' controversial policies.
However, from the creditor standpoint, the blink scenario could unravel the 2010-14 austerity policies because it would provide an incentive for other fragile euro economies to engage in similar hard bargaining with the Troika and thus reverse much of the past progress.
So another scenario is that, instead of the Troika, Syriza will blink. In this scenario, the radical left would allow the dilution of its social policies, but not its pledge of an international debt conference. The party would seek debt relief reminiscent of that granted to Germany in 1952 (62 percent). This scenario would cut significantly the general government debt, which today exceeds 190 percent of the Greek GDP.
In this case, Tsipras would be likely to get a call from the ECB and his response would be: "Do your worst."
But what if neither the Troika nor Syriza would blink?
In this scenario, the Troika would bet that the radical left will collapse politically under escalating economic pressure. Whereas Syriza would presume that the Troika would not dare to show the euro door to Greece because that would risk the progress that Brussels has achieved since spring 2010.
In this scenario, the subsequent volatility would shake the markets, and Athens would be forced to exit the euro zone, which would serve as a warning to Italy and France to stay the course. In turn, Brussels would bet that it can absorb the shock associated with consequent economic shocks.
Whatever the final scenario, the repercussions will reverberate not just in Greece or the euro zone, but across the global economy
