Bankers, governments and investors are preparing for Greece to stop using the euro as its currency, a move that could spread turmoil throughout the global financial system.
Tag Archives: bailout
GLOBAL ECONOMIC COLLAPSE – STARTING WITH GREECE
How shock waves will reach the US if Greece drops the euro
Greeks will have to wrestle with a crucial dilemma when they go to the polls for the second time in as many months on June 17 to elect a new government.
Greeks will have to wrestle with a crucial dilemma when they go to the polls for the second time in as many months on June 17 to elect a new government.
A Greek election on Sunday will determine whether it happens. Syriza, a party opposed to the restrictions placed on Greece in exchange for a bailout from European neighbors, could do well.
If Syriza gains power and rejects the terms of the bailout, Greece could lose its lifeline, default on its debt and decide that it must print its own currency, the drachma, to stay afloat.
No one is sure how that would work because there is no mechanism in the European Union charter for a country leaving the euro. In the meantime, banks and investors have sketched out the ripple effects.
They think the path of a full-blown crisis would start in Greece, quickly move to the rest of Europe and then hit the U.S. Stocks and oil would plunge, the euro would sink against the U.S. dollar, and big banks would suffer losses on complex trades.
ACT I
What would Greece’s exit look like? In the worst case, it starts off messy.
The government resurrects the drachma, the currency Greece used before the euro, and says each drachma equals one euro. But currency markets would treat it differently. Banks’ foreign-exchange experts expect the drachma would plunge to half the value of the euro soon after its debut.
For Greeks, that would likely mean surging inflation — 35 percent in the first year, according to some estimates. The country is a net importer and would have to pay more for oil, medical equipment and anything else it imports.
Greece’s government and banks currently survive on international loans, and if it dropped the euro, the country would probably be locked out of lending markets, says Athanasios Vamvakidis, foreign-exchange strategist at Bank of America-Merrill Lynch in London. So the Greek central bank would need to print more drachmas to make up for what it could no longer borrow from abroad.
That’s one reason analysts say the switch to a drachma would lead the country to default on its government debt, possibly triggering losses for the European Central Bank and other international lenders.
Most assume foreign banks would have to write off loans to Greek businesses, too. Why would Greeks pay off foreign debts that effectively double when the drachma drops by half?
Say a small shop owner in Athens has a €50,000 business loan from a French bank. She also has €50,000 in savings in a Greek bank. The Greek government turns her savings into 50,000 drachma.
If the new currency fell by 50 percent to the euro as expected, her savings would suddenly be worth €25,000. But she would still owe €50,000 to the French bank.
European banks would take a direct blow. They’ve managed to shed much of their Greek debt but still held $65 billion, mainly in loans to Greek corporations, at the end of last year, according to an analysis by Nomura, a financial services company. French banks have the most to lose.
Global Economic Collapse – Why Hasn’t Obabma Prepped the U.S For Economic Doomsday
Why hasn’t Obama doomsday prepped the U.S. economy?
OK, here’s where we are right now, and it isn’t good:
1. Europe is in recession, and its financial crisis is growing worse. The bailout of Spain was a bust. Yields on Spanish bonds are now at their highest point of the crisis. Here’s looking at you Italy.
2. The sputtering U.S. economy may well be heading into another recession, and the approaching fiscal cliff is hardly helping confidence. It sure looks like nothing will be done on that front before the election.
3. Three-fourths of the BRICs—China, India, and Brazil—are all slowing. There go the emerging-market growth engines.
How to avoid a worsening of this already dire scenario? AEI economist John Makin thinks four steps are urgently needed:
1. Europe’s banking system must be stabilized to end runs from depositors withdrawing funds;
2. Europe must articulate clearly a framework for rapid evolution toward fiscal union;
3. The policy mix that includes additional fiscal stringency in return for rich loans to Europe’s periphery must be softened.
4. The ECB can help calm markets and reduce uncertainty by signaling its support of more accommodation, including a system of deposit insurance for European banks and could cut interest rates by fifty basis points and undertake another round of extra lending to ensure ample liquidity to banks.
I would add that Europe should be cutting taxes, not raising them.
But here’s the problem: As Makin notes, the odds of all that stuff happening are low, maybe a 50% chance depending on “Greece electing a coalition government willing to cooperate with Europe’s core countries to move toward a true monetary and fiscal union.”
So we have a) a 50% probability of a cooperative outcome from the Greek election on June 17, and b) conditional on that, a 50% probability that Europe will be able to quickly move forward to enact a more credible monetary and fiscal union.
Do the math. The joint probability of these events is 25% at best, “meaning there is only a one in four chance that the euro system will survive through the summer. Should the more likely outcome—an acute European financial crisis—emerge, the United States will be forced to act to prevent serious damage to its financial system and economy.”
So we have a 75% chance of a nightmare summer and autumn heading smack into the U.S. elections in November. The only question is how bad it will be. We don’t know what’s beyond the veil formed by the EU financial crisis, so any predictions about Obama vs. Romney are pretty much worthless.
But it’s hard to see how a financial shock would help the Obama campaign. He is the incumbent, after all. While the president cannot be blamed for the financial crisis, the Romney campaign could charge him with not doing everything possible to doomsday prep the U.S. economy for another global economic shock. It’s not like the EU debt crisis popped up in the past few weeks.
Why do we still have the highest corporate tax rate in the world?
Why did Obama nix the Keystone pipeline?
Why is the president still talking about raising taxes?
Why has the White House offered no long-term debt plan to reassure global markets?
Already, Romney has been hitting Obama for becoming obsessed with passing healthcare reform in 2009 and 2010 rather than boosting economic growth and job creation. Expect more of that.
And if the economy slows further—and if Obamacare is tossed by the Supreme Court—it’s a message that may powerfully resonate with voters.
