The fallout from the Greek election result continues unabated,with riskier assets continuing to be sold off and safe havens such as US Treasury bonds, UK gilts and the US dollar in demand. The euro continues its decline as an exit for Greece from the eurozone seems more likely than ever. With Greek politicians unable to form a coalition government as of this afternoon, it looks likely Greeks will be returning to the polls to decide whether their heart or head rules. The approach of a renegotiated financial deal between the EU/IMF reducing the level of austerity measures for Greece seems to be possible in the eyes of the Greek electorate, however Germany and others are unlikely to countenance a bail out without the existing strict conditions on reductions in government spending and asset sales.
So the Greeks are playing a game of chicken with the EU, betting that they will blink first when it comes to the resumption of the Drachma as the national currency. The more extreme Greek politicians are hoping that the fear of contagion to Portugal, Spain, Italy and others will bring them back from the brink. However, EU finance ministers meeting today may decide to cut the rip cord and leave Greece to its own destiny, with an enlarged ECB bail out fund to ring fence Greece and prevent contagion. Investors in Greece have already taken big hair cuts on their bonds, so the damage to the European banking sector can be managed with additional liquidity.
An exit of Greece from the euro is likely to result in a dramatic reduction in living standards in the short term, with expectations that the reduction of the Drachma will result in a 30-50% devaluation. This means more expensive imports, a dramatic reduction in wages and pensions versus the rest of the EU, and fears of capital flight to safer countries.
A mess indeed meaning that UK investors are picking up the pieces as fears of a disorderly exit for Greece mount, with European contagion similar to the impact that the bankruptcy of Lehman Brothers had in 2008. Banks hoarding cash, a sudden loss of global liquidity, collapsing stock markets, frozen credit markets, a lurch for the economy into global recession.
You would hope that the IMF, Germany, France and others would be anticipating this dire scenario and be preparing appropriately. Unlimited powers for the ECB to buy distressed sovereign debt in Spain and other countries, a back stop in effect similar to the US TARP (toxic asset relief programme) to protect financial institutions and ease liquidity concerns. Germans may not be relaxed about the potential impact on their fiscal responsibilities but there seems little alternatives unless the euro experiment is allowed to end in calamitous circumstances sending stock markets around the world potentially to the lows of 2009.
After years of postponing the Greek problem, at least we will see a solution one way or the other. Whether it is a positive outcome is in the hands of the politicians, and politics as we all know can be a dangerous thing!
Contrarian Investor UK