Indeed, if the Greeks think that the current situation is bad, then it’s nothing compared with what’s in prospect if the country’s financial lifeline from the IMF and ECB is cut off as would be the natural consequence of a Syriza-led government defaulting on its EU bail-out debt obligations. It’s a high stakes poker game, but one where the EU leaders hold all the aces.
It’s different now
For starters, the situation is dramatically different from 2011 when fears of a Greek meltdown sent the euro and equity markets plunging, gold soaring, and resulted in severe stress in the European financial sector. This prompted the European Central Bank (ECB) to address these financial concerns by forcing a recapitalisation of the region’s banks and offering them cheap funding lines under its Long Term Refinancing Operations (LTROs). But as I noted in last month's feature (‘Fireworks to set markets alight’, 19 December 2014), the region’s banks are now redeeming these debt obligations as they mature even though the ECB are offering them similar lending terms under new LTROs to enable a controlled roll-over of the debt. That is not the sign of financial distress.
And it’s not just the banking system that is in a far stronger position as the ECB has also introduced a mechanism to prevent financial contagion spreading across the region by backstopping the bond markets through sovereign bond buying. True, this back stop has yet to be called upon as the message from ECB President Mario Draghi that the central bank would do “what ever it takes” has so far been enough to drive down sovereign bond yields across the region to record lows. Admittedly, current yields mainly reflect a high probability that the ECB will indeed launch its bond bazooka shortly.
In an ironic twist, even if a Syriza-led government did decide to commit financial suicide and renege on its debt obligations, then this makes the introduction of unsterilized quantitative easing by the ECB even more likely. There would not be a single bond trader in the world that would try and bet against the ECB if it launched its €1,000bn bond bazooka in an attempt to reflate the region’s beleaguered economy and stop contagion spreading into other EU sovereign bond markets. It’s noteworthy that while Greek debt has plunged in value since the country triggered an election last month after the incumbent coalition government led by premier Antonis Samaras failed to elect a president - yields on 10-year Greek government debt have surged from 5.9 per cent in September to 9.5 to 10 per cent - yields on 10-year German, Italian and French government debt have contracted by 65 to 80 basis points to record lows in the same period. And in another twist of fate, the ECB’s governing council has scheduled its next meeting on Thursday, 22 January, three days before the Greeks head to the polls. There is a fair chance that the bond bazooka will be launched either before that election is held or in its immediate aftermath.
Decision time
Of course, the Greek population may yet decide that a vote for Syriza and financial repudiation is not in their best interests, just as the Scots decided by some majority in September that an exit from the Union was not in their interests either despite the polls suggesting the result was too close to call. The Greeks would do well to ponder the consequences of their actions as there is no chance whatsoever of the rest of the EU agreeing to yet another debt restructuring. Undoubtedly, the threat from Mr Tsipras is real, but make no mistake that if elected his bluff will be called by the EU, and at a stroke his €2bn programme of humanitarian measures targeted at the less well off would be in tatters. The programme to woo the voters includes higher pensions, free electricity for 3 per cent of the population, free medicine and hospital care for the unemployed.
Still, it’s worth considering the likely sequence of events that would immediately follow a non-negotiated default on its debts by Greece if Syriza take power and fail in their demands for a renegotiation of the country’s €245bn bail-out package. Firstly, Greece is reliant on the “troika” of International Monetary Fund (IMF), European Financial Stability Facility and the ECB which in aggregate own over three-quarters of its debt.
At the latest count, the country’s total borrowings stood at around €319bn, or the equivalent of 175 per cent of GDP of €182bn. This debt includes €245bn of financial bailouts of which €44bn is vital liquidity support from the ECB to Greek banks, a sum accounting for almost 14 per cent of the country’s total borrowings. In addition, Greece needs around €28bn for its funding needs in 2015/16, or the equivalent of 14 per cent of GDP. The country also has to make payments totalling €11bn for debt and interest payments to the EU between March and August this year. In the circumstances, the only line of credit available to Greece is from the troika as the country is not surprisingly being shunned by outside investors. Bearing this in mind, it’s worth noting that Greece doesn’t pay interest at all on its official EU debt, or not until 2023.
Implications of a Grexit
So, if Syriza is elected and in the worst case scenario repudiates on the country’s debt, the majority of which is priced below the rates of interest the country would otherwise be able to borrow at, the withdrawal of the ECB liquidity line of credit would be immediate. It would also force the exit of the currency from the euro and with it a flight of capital from the country. Without this vital support the Bank of Greece would have no choice but to return to a free floating drachma and ramp up its printing presses. It’s not scare mongering to suggest that the currency, which was fixed to the euro at an overvalued rate of 1 euro:340 drachma when Greece entered the single currency 15 years ago, could devalue by at least half if Greece left the euro. In a non-negotiated exit scenario, the Bank of Greece would be forced to print money as if there is no tomorrow to fund the government’s debt obligations and pay its bills. Inflation would soar and Greece would be in the grips of a financial Armageddon. It’s scary stuff and should be giving the Greeks nightmares. Let’s hope for their sake that those nightmares whittle down the 4 percentage point lead of Syriza in the polls by the time the election is held. The potential for years of severe financial oppression may yet focus the mind of the population even if the current economic climate under Antonis Samaras’ coalition seems unpalatable. The next month is going to be interesting to say the least, but for the sake of the Greek people I sincerely hope that sense prevails.
In the meantime, I would continue to play this unfolding Greek tragedy through the ongoing US dollar strength against the euro, a prediction I highlighted in my Eurozone feature last month (‘Fireworks to set markets alight’, 19 December 2014), since when the euro has weakened from $1.25 to $1.19 against the greenback. Further strength of the US dollar seems highly likely for a number of reasons.
That’s because if there is a further spike in risk aversion then the US dollar will undoubtedly see a flight to safety as the world’s reserve currency. And if Syriza is elected then the threat of financial repudiation on Greece’s EU debts will be enough to undermine the single currency. But the major reason is the increasing likelihood that the ECB will embark on unsterilized quantitative easing through sovereign bond purchases which will weaken the euro as a natural consequence.
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
