It is not time for Greece to exit, yet

I wrote about Greece on this blog many times. From the beginning my view was that unless 80% of the Greek debt is forgiven financial markets will bring out the weakness in the Greek economy and the euro area design. Also, I said that until a solution imposed by EU policy makers would not resemble one that would have been imposed by the markets the Greek story will continue. The same is true for the others in the PIIGS group.

When it comes to this type of analysis you will get two views: what the analysts thinks it should happen and what the analysts think it will happen.

I am going for the second type of analysis as this is the one that mattes for all of us and especially for investors. In my view Greece will not exit the euro at this point. Although the EU leaders have changed their speech a little bit I am sure that they are not speaking to the financial markets but to the Greek people when they say they are ok with a Greece exit. They are not ok. First of all the timing is terrible. An exit of Greece prompted by the financial markets will push the markets to overshoot the impact of such a decision. If there will ever be an exit from the euro area it will be done when the framework of the euro zone would have been changed to allow for such an exit. Otherwise the precedent started by an exist of a country due to financial markets pressure will not be contained by EU leaders and next we will face the possibility of three or four more countries asked to either reform fast or exit. This is in fact the main risk for the euro zone: total break up not just losing Greece.

Thus, I do not believe that Greece will exit soon the euro zone. However, there is a sector that will suffer in the short term either way. For Greece to stay in and have a future more of the debt will have to be cut. This means that the banking sector, the very same institutions that have been funding Greece even at a rating of “junk”, will have to book more losses. But this would have happened even if Greece will exit the euro zone tomorrow. Banks will have to write off their claim (or most of it) on Greece in either scenario.

Going back to 2008 what would have been the market solution then for those institutions that made bad investments and stretched way beyond their funding means? Bankruptcy or massive restructuring. 4 years later and 20% extra public debt/GDP for the euro zone and we will get the same result: restructuring in the financial sector (mostly banking).

P.S. More detailed implication are presented in a report for my clients.

13 thoughts on “It is not time for Greece to exit, yet

  1. You are missing an important point here. Non-Institutional greek bond holders have already incurred heavy losses. Most of the debt now is held by the IMF, ECB, and EC. This debt is not to be defaulted on according to current agreements. So there is no more space to cut debt unless the above mentioned international institutions accept it. Even if private banks accept a 100% loss (which would trigger an CDS event), greek debt would still be unsustainable.

    http://www.rba.gov.au/publications/smp/boxes/2012/may/b.pdf

  2. Can you explain me if The National Bank of Greece has to take back to the ECB all the monetary mass M1 in euro they received in exchange for the old drachma notes? That makes another astonishing figure…

    As they received it for free and the ECB printed it from thin air, for me it’s obvious that they have to take it back to be sterilized. Otherwise it will create inflation or it will be an unfair gift in respect with the other members.

    1. @Marius
      The ECB cannot take the money back. The Greek National bank will have the option to use the EURO and introduce the drachma in parallel. slowly the central bank will introduce the drachma by buying the Euro. But like in Romania, Drachma could be used in parallel with the euro or dollar.
      In my view this would be a mistake as the drachma will lose in the long run, much like the RON is losing now.

      1. And who do you think that will go to sell his/her Euros for Drachmas? What should he/she do with those Drachmas?
        Of course, they will have to pay their taxes in Drachmas, and the Greek Central Bank will have more and more Drachmas to sell and nobody to buy them back.
        The same way they could use some sticks, or shells they will have the same value as those Drachmas.
        The exit is not a solution. Beside, I think that the Euro will suffer biiig time! First of all there will be an Euros excedent of monetary mass (the mass related to Greece). Second: If Euro was built as an act of faith in the eurozone’s economy, the exit of the first nation in trouble will be the signal for everyone that euro-countries will not support this currency if it is a rainy day. So if they are not supporting the Euro, why should private owners support it with their trust?
        I bet that the first effect of the exist will be that Romanian commercial contracts will switch rapidly to USD refference instead of Euros.

  3. If Syriza will won the elections, since they are anti-bailout, I think the Grexit will be inevitable.
    Maybe this would be a better solution for the Greeks, heavy pain short-term and a better future later.
    Latest polls say New Democracy will win. If they will make the government, Greece will stay in the Euro-zone but will still have very tough times.

  4. I guess drachma shouldn’t be a gift, as the debt is denominated in euro. Drachma was replaced by euro at a certain parity in 2002, which is not similar at all with the “new” parity, if we go talking about Grexit. A unitary parity (1 drachma for an euro) at fix rate will create inflation as soon as new drachma is printing and as the “new” Greek is facing inflation, the inflationary effect will push the Greek NB and ECB to think about the Greek interest rates.

  5. If going to drachma will bring all values to half of their original one, the greeks can have a very simple solution for their problem. The new currency should be “The Half Euro”, but all payments should be made in euros…

    The steps are:
    1. The authorities declare ‘force majeure’ and default on their external debt.
    2. Immediately, all existing bank deposits are ‘frozen’. A bank holiday is declared.
    3. The banks are taken for a month under strict governmental control.
    4. A “new currency” is announced: “The Half Euro” and all existing bank deposits are redenominated in the “new currency”, at a devalued rate of 50%.
    5. All existing debts and claims are redenominated in the new currency: both government and private sector. Wages, pensions and benefits are paid in the “new currency”.
    6. Instead, all payments should be made in euros.
    7. Every contractual part can denounce any existing contract in half of its original term.

    Everything registred between greek entities on contracts, legal paper or books, should be downsized to half. Everything registred between greek entities and foreign entities, or outside Greece, should remain at its original value. All the cash on hand should remain cash on hand, with its euro denomination.

    No bank should be nationalized, all banks have in ballance deposits to pay and loans to collect. In theory, even if cut in half, they should balance.

    1. @Marius
      I am not sure that you can control things this precisely. The main risk is that the situation will turn out worse than any scenarios. That is why I think the best strategy to exit the EURO is when there is a moment of “serenity” in the global financial markets.

      In the same time the entire euro zone is putting itself at the mercy of the markets if it allows Greece to exit right now. Letting Greece exist while the euro zone economy is still dealing with problems in Spain,Portugal and Ireland will be the end of EURO.

  6. I don’t think there will ever be a “good moment to exit”. it will be like Florida will exit the dollar….. Euro was born as the complete trust in the benefits of one united Europe. If Europe is not united, the Euro is lost.
    Now the united Europe shows weakness. The answer should be more like a Marshal plan for PIGS, not the exit of any of these countries from the euro zone.
    All the exit strategies are loosing strategies, it is a lost-lost situation. If the western economy could be reconstructed after the WWII, I bet there is a possibility to reconstruct a small economy like the Greek one. Other strategy should be to print more Euros to make large investments in the weak euro economies.
    The euro countries should try to build confidence in Euro, not to dig around its foundations.

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