World markets are bracing themselves for an ugly start to the trading week following the surprise decision from Greek Prime MInister Alexis Tsipras to hold a referendum next Sunday in which Greek citizens will vote on whether to accept the latest bailout proposals from the country’s creditors. The Greek government had previously rejected the revised bailout package which included up to EUR 15.5b in funding over the next five months from the EU, IMF, and ECB on grounds that the austere conditionalities went against their mandate to govern from the Greek people. Greek finance minister Varoufakis explained the government’s decision by declaring the proposals offered “no hope” for investors and consumers, and certain aid conditions would almost certainly be recessionary for Greece in the long run. As a result, the government plan is for the Greek people to decide for themselves, but in a dramatic twist of events typical of the whole sorry saga of the Greek crisis, it seems unlikely they will have anything to vote on. The Eurogroup head Dijsselbloem has already confirmed that the current proposals will expire on Tuesday night, and will not be extended regardless of the Greek government’s request to do so. As a result, without some last minute climb down from Greece’s creditors, it is increasingly unclear what exactly the Greek people will be voting for next Sunday.
It appears all avenues of political negotiation are closing up, and following years of trial runs, it appears Greece’s moment of reckoning is imminent – both sides appear entrenched within their relative positions and the Grexit event, the seemingly never fading threat facing markets for years is upon us.
What will contagion from a Greek default look like?
Up until recently, any potential contagion from Greece has been largely ignored by the broader market. If Greece, as seems increasingly likely, is to default and leave the EU, the effects would be concentrated predominantly in world stock and bond markets. While banks in Europe and the United States have provided repeated assurances that their exposure to Greece is manageable, confidence in Wall Street models is shaky at best, and there is considerable concern that complacency has crept into consensus analysis regarding the potential impact from Grexit.
Fears over unusual market volatility are starting to show up in a variety of places, with reports of some fx brokers limiting trading activity to “close only” on Monday in an attempt to limit the expected carnage. A Greek SEC has also warned that the Athens Stock Exchange may not be able to open on Monday should ELA assistance be withdrawn by the ECB. Without the ELA several Greek banks may also be unable to open on Monday, and many Greek citizens have been rushing the ATMs since Tsipras’ surprise referendum decision last night. Lines began forming to withdraw money by 2am, and many ATMs have since run dry of cash. Bloomberg is reporting that several Greek Banks are limiting cash transactions, and further restrictions are likely to be in place for the banks that do open on Monday.
What could the longer term consequences of Grexit be?
Markets worldwide are already in a state of relative fragility and any serious fallout from Grexit could lead to some serious headline selling pressure for the world’s major markets. Should recessionary threats increase due to the upcoming event, it would seem that more QE from the world’s central banks would be on the table – in the ECB’s case, increased QE looks almost a certainty. It has been no secret throughout the whole Greek saga that a weak Euro is of great benefit to the core nations of Germany and France. Any strengthening in the Euro would be welcome to say the least. Increased QE from the ECB, which as we said, looks to be a certainty, would also severely constrain the Federal Reserve’s ability to raise rates going forward. A weakening Euro is already a default rate hike for the US via the dollar proxy. A rate hike would strengthen the dollar even further and begin to cause serious difficulties for American exports – something the Fed will no doubt be monitoring closely.
For Greece, the long term implications are less clear. There will undoubtedly be a severe amount of short term economic pain as the country adjusts to life under a new economic reality, and potentially even a new currency. Finding credibility within the world market will be difficult at first but it will eventually come back. Greece has been saddled with an increasing debt burden for too long, an exit may give the country a welcome opportunity to start again, and start building an economic future hopefully free from the unsustainable amounts of debt and uncertainty it has been carrying for too long. The Greek people certainly deserve as much.
Andrew McCarthy is an expert in all things inflation. He has a Bachelors in Economics and has been working in the finance industry for over two decades.
