Markets have been rattled by the most recent Greek drama unfolding as negotiations over another bailout have stalled. If, as seems increasingly likely, Greece defaults and exits the Eurozone, the ramifications for the world economy should be fairly modest.
Our opinion is that it could even turn out to be a positive development as both the Eurozone and Greece itself may benefit from a separation in the longer-term. Greece would have greater flexibility to handle their severe financial obligations and the Eurozone would be able to telegraph to markets and member states that there are consequences associated with sustained imprudent financial decision-making.
Unfortunately, the most likely scenario centers around continued bailouts and short-term solutions.
Greece’s share of world GDP has fallen from only 0.6% in 2008 to just 0.3% this year (about the size of San Diego). This slow moving train wreck has given the European economy, and the broader world economy, plenty of time to build firewalls in order to avoid systemic risks. The bulk of Greece’s debt is now held by official creditors, who are much better placed to bear any losses compared to the private sector and should not be a channel for contagion. The exposure of European banks to Greek debt has been slashed to just $50 billion at the end of 2014. At the same time the ECB (European Central Bank) is in a far stronger position to weather the storm than it was during the last Greek crisis. After the initial pain of default and devaluation associated with reintroducing a uniquely Greek currency, Greece could undergo at least a few years of rapid growth and it is also possible that confidence in the rest of the Eurozone will be given a temporary boost once the uncertainty surrounding Greece has been lifted.
The cradle of western civilization is in for some hard times in the short-run. The IMF has projected that the reintroduction of the Drachma as Greece’s currency would result in a 50% plunge against the Euro, a drop in GDP by 8%, and inflation rates above 35%. Many of Greece’s 2.9 million retirees have seen their pensions slashed by 45% since 2010. Beyond Greece, in a world focused on “short-termism” volatility will likely pick up and push investment markets in to the red nearing the half-way point of 2015. This narrow-minded focus increases the likelihood that a short-term, poorly constructed, last-minute bailout presents itself that only leads to a revisiting of the problem in the not so distant future.
The Eurozone was not designed to have member states exit, so there is no guidebook or precedent to follow. The paramount concern is that contagion seeps in to other weak southern periphery European countries such as Spain, Portugal, and Italy that are large enough to wreak havoc on global financial markets if volatility accelerates. If Greece does exit, it could embolden fringe political parties in other countries to demand a departure from the European monetary union. An investment flight to safety could commence resulting in massive inflows to U.S. dollar based assets furthering pushing up our currency against the Euro. This could further delay the timing for raising interest rates in the United States as the Federal Reserve seeks to calm nervous markets. The Federal Reserve has not increased interest rates in nearly a decade, and the longer we delay a modest pace upward the worse positioned we are for the next major economic downturn.
In summation, we believe the current Greek crisis will be transitory in nature and a general, albeit slow, positive trend will recommence. This opinion will have to be re-examined, however, if a worst case scenario manifests itself ensnaring the larger global community. Unfortunately, the most likely scenario in our opinion entails another kicking of the proverbial can down the road as stimuli, stimuli, and more stimuli continue to be the easy, short-term solution de jour. As always, thank you for your continued trust, confidence, and support in our investment process, long-term strategy and constant vigilance.
Chief Economist and Lead Portfolio Manager
Bukaty Financial Services
*Securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through Bukaty Companies Financial Services, a registered investment advisor and separate entity from LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.