There you have it. In what should come as no surprise to anyone, the Greek people have voted no to further austerity measures. The referendum resulted in a resounding 61–39 vote in favour of rejecting the bailout terms.
Yet the ‘no vote’ has left the European Union in uncharted waters. The decision has put the entire future of the European project in doubt. Not that this should excuse the abuse the Greek people have been through. We can’t begrudge them for wanting to take control of their own destiny.
They’ve been put through the meat grinder for years with little to show for it. From sky high unemployment to tax hikes, austerity has not made Greece a happier place to live.
But now that Greece’s future in the Eurozone looks shaky, the question on everyone’s lips is: what happens next?
Since the government announced a referendum a little over a week ago, Greece’s long term viability in the Eurozone has come under renewed scrutiny. A ‘yes to austerity’ vote would have calmed both global markets and European leaders. At worst, it would have doused any likelihood of a contagion spreading throughout Europe, taking down Italy and Spain with it.
But the no vote has swung things completely. We’re now left with little else but to consider the real possibility of a doomsday scenario playing out.
The Greek government had hoped a no vote would strengthen their position in the bailout negotiations. They may be right to an extent, but I believe they’re overestimating their hand here. Whatever leverage they think they got from the referendum fails to account for the anger now rising in influential EU ranks.
So while Greece may want to stay in the Eurozone, the no vote may have all but jeopardised their chances of doing so. The real power now lies with the European Central Bank and European Union. They’ll decide whether or not to continue providing liquidity to the Greek banks. Right now, we can’t say for sure which way things will go. But we’ll know more by 20 July. That’s the day that Greece faces a potential default on bonds held by the ECB.
Yet the chances of reaching an agreement over the bailout terms are slim between now and then. Firstly, there needs to be political will from Brussels to reach a compromise. Right now, there’s no guarantee of that happening.
What’s more, how will Germany’s Angela Merkel convince voters and banks of renegotiating the debts given that Greece has now rejected austerity?
She won’t, which makes a Grexit all but inevitable.
The problem is that any failure to restructure their debts will only lead to one outcome: the end of liquidity for Greek banks. The ECB would have little choice but to shut down the Emergency Liquidity Assistance program.
Were that to transpire, Greek banks would have no money left to lend. That would leave them on the brink of insolvency, at which point the Greek economy would implode within days.
What happens when the ECB cuts liquidity to Greek banks
With the potential for such a dramatic economic collapse, the Greek government wouldn’t have long to act. They would be forced to take over the Greek central bank, issuing new liquidity to banks in the process. Since Greece wouldn’t be able to print euros, they’d have no choice but to print a new currency. At this point, we’d likely see the reintroduction of the drachma.
Yet printing another currency is in direct violation of the Economic and Monetary Union Treaty. As a result, the EU would have no choice but to kick Greece out of the Eurozone. As British bank Barcalys reports:
‘Assuming that all of the pledged collateral at the ECB is recorded at (close to) par on Greek banks’ balance sheets and the current average haircut on collateral is 50%, then retention of the collateral by the Eurosystem would translate into a more than 30 billion euro loss for the banks.
‘The Greek central bank will eventually need to print its own currency in order to inject new liquidity and capital’.
Barclays are less convinced this would be a bad outcome for creditors. They highlight that the exposure of Eurozone members to Greece amounts to 3.5% of euro area GDP. What’s more, European banks are even less exposed to Greece, with a figure of less than one-tenth of GDP.
Barclays says this will ensure that any European bank losses will be limited as a result. If that’s the case, then why are the EU and ECB so intent on keeping Greece in the Eurozone?
Why keep Greece in the Eurozone?
The answer to that is that the fallout from Greece has the potential to cause a contagion across the rest of the Eurozone. Politically, both the EU and ECB have a vested interest in preventing this from taking place.
If Greece is forced out the Eurozone, and potentially the EU too, then Italy, Spain or Portugal could be next. All three nations have a debt to GDP ratio above 100%. And, outside of Portugal, we’re also talking about much larger economies than Greece, with greater scope for mayhem. Spain and Italy could rock European and global markets unlike anything we’ve seen with Greece.
The Germans are leaning in favour of a Grexit
Germany is likely to reject any compromise over the bailout negotiations. Whatever Greek leaders think about their bargaining position now, they’ll have an irritated Germany to contend with. As the most influential Eurozone partner, Germany will have the final say on the future of Greece.
Make no mistake, the big losers from the referendum will be German banks. They’re the ones who provide much of the liquidity for Greek banks. And they have the most to lose from a Grexit.
What we’ve seen following the referendum is that German bureaucrats will take a hard-line against Greece. They’ll find it difficult to convince voters that Germany should cave in to Greek demands. Naturally, that’ll make the prospects for a compromise highly unlikely.
Nonetheless, the Germans will have to weigh up restructuring the debts versus the real risk of contagion spreading. They’ll probably try and convince voters that the Eurozone could handle a Grexit.
I expect to see EU leaders ramping up their rhetoric in the weeks ahead. You’re going to hear a lot more about Italy and Spain, and why they are different from Greece. But remember, it wasn’t long ago when Greece’s position in the Eurozone seemed secure. The landscape, as we’ve seen, can change rapidly.
Aussie dollar falls on Greek referendum
The Australian dollar dropped to below $0.75 for the first time in six years on the news of the no vote. The euro expectedly dropped against the US dollar, falling 1.3%. Safe havens like gold were up by 0.5%, trading at US$1,174 an ounce.
In early trading, the ASX200 was also down by 1.4%, shedding $22 billion off the market. The major banks dropped between 1.1% and 1.5%. Commodity giants BHP Billiton [ASX:BHP] and Rio Tinto [ASX:RIO] were also down by 2% each.
The real test for markets will be later today when European share markets open. Speculation in the lead up to the referendum last week sent markets in Europe and US tumbling by 4% and 2% respectively. The selloffs are likely to be much worse throughout the week when both reopen later today.
The key thing to watch will be to see whether European bonds yields reflect doubts about the ECB’s ability to weather the fallout of the Greece’s debt defaults. The most important aspect here will be to see what the ECB does to prevent jitters over a contagion spreading. If no measures are forthcoming, then markets may continue to fall indefinitely.
Nonetheless, the flight to safety will see investors buy US dollars and gold in greater quantities. In turn, the Aussie dollar should drop further against the USD over the coming week.
Any prolonged inaction in managing the potential for contagion will be good for both the US dollar and gold. But with the whole European project at stake, expect to see the EU and ECB act quickly to restore confidence.
Contributing, Markets and Money
PS: The turmoil in Greece, alongside China’s stock market hiccup, is bad news for Aussie markets. What’s more, the outcome of both of these issues suggests that the ASX is in line for much bigger losses soon. It’s hard to remain bullish on the future of the local share market when the economic prospects look so poor.
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