To cut a short story long…
Details of how much a disorderly Greek default would cost the Eurozone entered mainstream circulation yesterday. It was not good news. The document leaked from the Institute of International Finance (IIF) estimated a cost of over 1 trillion Euros. The large proportion of that sum is comprised of substantial support for other weak Eurozone economies – 380 billion Euros for Ireland and Portugal, 350 billion Euros to Spain and Italy, and 160 billion Euros to cover the exposure in the rest of the Eurozone.
Some investors have dismissed the report as simple scare tactics aimed at getting private sector (PSI) bond holders on board in the latest debt restructuring scheme. They claim the strategic timing of the ‘leak’ gives away its real purpose – along the lines of: ‘If you creditors don’t join us (and lose 50% nominal value and 70% real value of your bonds) then look what will happen! The Eurozone will collapse and you will be left with even more dire circumstances. Get on board the debt write down bandwagon now… Before it’s too late!’
However the IIF report was first published by Athens News over 2 weeks ago on February 18th. So although the document received its prolific exposure in the press only one day prior to the PSI debt swap deal, the timing is more a product of media sensationalism than conspiratorial conjecture. The fact of the matter is that 1 trillion Euros is a very realistic figure.
If the PSI deal goes ahead smoothly on March 8th – and it probably will – expect the Euro to post muted gains. The market response to the Greek odyssey / ordeal has generally been of the obligatory nature rather than the conclusive; the optimism will not last.
Even when all corners of the patched-up bailout deal are sewed together the long term outlook for Greece remains exceptionally weak.
Another leaked document – ‘Darn they should be more careful!’ – this one from the Troika, outlines the fragility of Greece’s growth trajectory. The harsh austerity measures imposed by the IMF, EC & ECB are designed to bring Greece’s debt-to-GDP ratio down from its current 160% to a slightly-better-but-still-extremely-depressing 120% in 2020.
The leaked Troika document details how the Greek economy will contract further before it begins to improve and forecasts that by 2020 the debt-to-GDP ratio will actually be closer to its current level of 160% than its targeted 120%. The report shows that a further 240 billion Euros will be needed if Greece has a realistic chance of following its growth projections.
Further aid tranches are looking less and less likely as sentiment within the Eurozone is growing increasingly sceptical to Greece and its long term restoration plan. Members of German Chancellor Angela Merkel’s Christian Democratic Union party have even spoken out against further increments:
“Quite clearly the mood in Germany is turning against further rescues for Greece. But that’s not surprising. This is all déjà vu for the public. We’ve been promised all kinds of things that aren’t fulfilled and then a few months later there’s the need for another rescue package. The public’s faith is fading fast.” – Klaus-Peter Willsch
If the Greek project becomes unsustainable and further bailout packages are not forthcoming then a Greek default remains a severe threat to the Eurozone – a one trillion Euro threat!
With financial activity during the Eurozone debt crisis as a character reference for the foreign exchange industry, it is not outlandish to predict how markets will react to a Greek default… by selling the Euro. You can expect masses of funds to flow across the Atlantic, nesting securely in the safe haven US Dollar. But many investors might not have the wings to take them all the way to the fabled ‘Land of the Free’ and will prefer the shorter voyage across the humble English Channel towards the Great British Pound.
As the year goes on and markets begin to price in the consequences of a Greek default, the Pound to Euro Exchange Rate is forecast to grow considerably, whereas the Euro to US Dollar Exchange Rate is forecast to suffer significant losses. 2012 could prove to be a real test for the Euro currency’s resilience, and although the ECB has just injected almost 1 trillion Euros into the banking system, the future of the Eurozone could be decided by the performance of its most profligate nation state.