UPDATE No Vote Pulls Ahead
Cash within the Greek banking system will run out in just a few short days, a senior banking source has told me, amid fears that the financial crisis will force Greek companies to start laying off workers on Monday.
“This is a fully fledged banking and economic crisis,” said the despairing source. “The rate of cash withdrawals has trebled in recent days, even with the limits.”
Since I arrived in Athens, I have witnessed Greeks queuing at those cash machines that are working, to withdraw the maximum amount of cash they’re allowed under the restrictions implemented last Monday.
“People are taking out money around the clock, out of ATMs, on the internet transferring to HSBC – you name it, they’re finding ingenious ways to get their savings.”
He added: “We desperately need a solution. It will not be long before our country is on its knees, with the damage so great that it will be permanent.”
After the referendum polls close tonight, Greek Finance Minister Yanis Varoufakis will meet bank bosses, grouped together under the auspices of the Hellenic Bank Association, and the governor of the Bank of Greece, Yannis Stournaras, I have learned.
All options currently remain open. Greece could do what Cyprus did: default on some of its debts while staying in the euro. Tsipras could decide to accept the tax increases and the pension cuts demanded by the creditors while receiving only minor and vague concessions on debt relief. Greece could have run out of money and be out of the euro within 24 hours.
Some things though are clear.
Firstly, the Greeks have said no to austerity rather than to membership of the euro. Tsipras does not have a mandate to bring back the drachma, even if that is where this all ends.
Secondly, the referendum result means both economic and political chaos. As Joan Hoey of the Economist Intelligence Unit put it even before the vote: “Greece is angry and fearful; divided and conflicted.”
Inevitably, Greece faces a fresh period of acute economic pain. It will take months, if not years, to recover from the events of the past week, even if there is a speedy resolution to the crisis. The Greek economy has already shrunk by a quarter in the past five years.
Thirdly, it is no longer possible to kick the can down the road. Any solution to the Greek crisis that involves more austerity without measures designed to get the economy growing again and to make the country’s debt sustainable will be a pyrrhic victory. The upshot would be a period of feeble growth and mounting indebtedness that would bring the possibility of Grexit back on the agenda. Sooner rather than later, in all likelihood.
Fourthly, this is the most serious crisis in the euro’s relatively short history. There have been confident pronouncements that Greece has been quarantined so that there will be no knock-on effects on the rest of the eurozone. Such sentiments will be tested to the full if there is a Grexit. Share prices will inevitably take a tumble when the financial markets open for business, but more attention should be paid to the bond yields – or interest rates – on the sovereign debt of other eurozone members seen as vulnerable.
The short-term problem for Merkel and Hollande is obvious. If they take a tough line in talks with Athens, they will get the blame for Greece’s departure from the single currency.
The longer-term problem is perhaps even more serious. Greece has highlighted the structural weaknesses of the euro, a one-size-fits-all approach that doesn’t suit such a diverse set of countries. One solution would be to create a fiscal union to run alongside monetary union, with one eurozone finance minister deciding tax and spending decisions for all 19 nations. This, though, requires the sort of solidarity notable by its absence in recent weeks. The European project has stalled.
So, this story is not over. In Homer’s epic tale, it took Odysseus 10 years to return to his Ithaca home from the Trojan war, losing all his men along the way. Greece’s modern odyssey, similarly, is only half over. The next chapter begins on Monday).
Expect lower stock prices.
Faced with an apocalyptic unemployment rate of 28%, voters in Greece have drawn the line on austerity measures that have mired the country in a crisis rivaling that of the Great Depression. In the worst case, the move could lead to Greece’s exit from the European monetary union. In the best case, it will produce much-needed debt relief for the country’s ailing economy. But either way, it’s prudent to assume the turmoil will roil equity markets both here and abroad.
The issue came to a head earlier this week when Greece’s “radical left” Syriza party won a plurality of votes in the latest election. Led by 40-year-old Alexis Tsipras, Syriza campaigned on a platform to ease the “humiliation and suffering” caused by austerity. This includes debt relief and rolling back steep spending cuts enacted by Greece’s former government in exchange for financing from the International Monetary Union and other members of the European Union.
To say Greece has paid dearly for these cuts would be an understatement. The consensus among mainstream economists is that austerity during a time of crisis exacerbates the underlying issues. We saw this in Germany after World War I when France and Great Britain demanded it pay colossal war reparations. We saw it throughout Latin America following the IMF’s structural adjustments of the 1980s and 1990s. And we’re seeing it now in Greece and Spain, where unemployment has reached levels not seen in the developed world since the Great Depression.
The problem for Greece is that Germany and other fiscally conservative European countries aren’t sympathetic to its predicament. They see Greece’s travails as its just deserts. They see a fiscally irresponsible country that exploited its membership in the continent’s monetary union in order to borrow cheaply and spend extravagantly. And they see an electorate that isn’t willing to accept the consequences of its government’s actions.
To a certain extent, Greece’s critics are right. Over the last decade, its debt has ballooned. In 2004, the country’s debt-to-GDP ratio was 97%. Today, it is 175%. This is the heaviest debt load of any European country relative to output.
It accordingly follows that the European Union stands once again at the precipice of fracturing. If the Syriza party sticks to its demands and Greece’s neighbors won’t agree to relief, then one of the few options left on the table will be for Greece to exit the monetary union and abandon the euro. Doing so would free the country to pursue its own fiscal and monetary policies. It would also almost inevitably trigger a period of sharp inflation in a reinstituted drachma.
This isn’t to say global investors should be petrified at the prospect of even the most extreme scenario — that of Greece abandoning the euro. In essence, the euro is nothing more than a currency peg that fossilized the exchange rates between the continent’s currencies in 2001. By going off it, Greece would essentially be following in the footsteps of the Swiss National Bank, which recently unpegged the Swiss franc from the euro after a drop in the latter’s value made maintaining the peg prohibitively expensive.
A more complicated question revolves around the fate of Greece’s sovereign debt. Seceding from the monetary union won’t eliminate its obligations to creditors. It likely also won’t change the fact that the country’s debt is denominated in euros. Thus, if Greece were to exit the euro and experience rapid inflation, the burden of its interest payments would get worse, not better. This would make the prospect of default increasingly attractive if not necessary in order to reignite economic growth.
But investors have shouldered sovereign debt repeatedly since the birth of international bond markets. Just last year, Standard & Poor’s declared that Argentina had defaulted after missing a $539 million payment on $13 billion in restructured bonds — restructured, that is, following the nation’s 2002 default. Yet stocks ended the year up by 11.5%. The same thing happened when Russia defaulted in 1998. Despite triggering the failure of Long Term Capital Management, a highly leveraged hedge fund that was ultimately rescued by a consortium of Wall Street banks, stocks soared by 26.7% that year.
Given all this, the biggest impact on investors, particularly in the United States, is likely to make its way through the currency markets. When fear envelopes the globe, investors flee to safety. And in the currency markets, safety is synonymous with the U.S. dollar. Over the last year, for instance, speculation about quantitative easing by the European Central Bank, coupled with the scourge of low oil prices on energy-dependent economies such as Russia and Mexico, has increased the strength of the dollar. This will only grow more pronounced if the U.S. Federal Reserve raises short-term interest rates later this year.
The net result is that American companies with significant international operations will struggle to grow their top and bottom lines. This is because a strong dollar makes American goods more expensive relative to competitors elsewhere. Consumer products giant Procter & Gamble PG 0.26% serves as a case in point. In the final three months of last year, P&G’s sales suffered a negative five percentage point impact from foreign exchange. As Chairman and CEO A.G. Lafley noted in Tuesday’s earnings release:
The October [to] December 2014 quarter was a challenging one with unprecedented currency devaluations. Virtually every currency in the world devalued versus the U.S. dollar, with the Russian Ruble leading the way. While we continue to make steady progress on the strategic transformation of the company — which focuses P&G on about a dozen core categories and 70 to 80 brands, on leading brand growth, on accelerating meaningful product innovation and increasing productivity savings — the considerable business portfolio, product innovation, and productivity progress was not enough to overcome foreign exchange.
With this in mind, it seems best to assume revenue and earnings at American companies will take a hit while Europe works toward a solution to Greece’s problems. In addition, as we’ve already started to see, the hit to earnings will be reflected in lower stock prices. There’s no way around this. But keep in mind that we’ve been through countless crises like this is in the past, and the stock market continues to reward long-term investors for their patience and perseverance.
“Irrespective of the referendum outcome, it is unlikely that there is an immediate resolution to the crisis the next day,” Marco Stringa, an economist at Deutsche Bank AG in London, wrote in a research note before the polls closed. “A ‘yes’ vote would be significantly more likely to lead to a quicker agreement with the creditors, but not without risks. Ultimately, the economic emergency will remain a key catalyst.”
A “yes” could force the end of the Tsipras government and fresh elections, a possibility to which Finance Minister Yanis Varoufakis alluded on Thursday. A result so close that it’s inconclusive may only extend the current stalemate, which began when Tsipras called the surprise plebiscite on June 27.
Some Greeks are despairing of their country’s situation.
“This vote is a test of our collective IQ,” said Hara Nikolou, a retired biochemist who lives on the island of Serifos, before casting her “yes” vote. “If our society opts to turn this country into Balkan wasteland, I don’t want to continue living here.”
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