Who says Greece is too small to impact world markets?
Posted By RichC on June 30, 2015
Seems like about every article I read pointed to the fact that Greece’s economy is only “half the size of Ohio” and that we are insulated from the turmoil over this game of chicken they are playing with the IMF and pending $1.73B payment default. Still traders on Monday in about every market decided this just might be the time to sell stocks? Ouch … it was quite painful if you are holding equities.
What’s the quick story on Greece?
Greece owes the International Monetary Fund (IMF) 1.5 billion euros on June 30th. Greece cannot pay that right now, so they are trying to borrow more money to pay the IMF. In order for the IMF to lend more money, they want Greece to agree to tough terms to rein in spending. That sounds good in theory, but these same terms make it hard for Greek economy to grow.
Greece unexpectedly announced a nationwide vote (or referendum) on July 5th to let the voters decide if they will agree to the loan terms. If the voters agree, the negotiations will end and Greece will accept the loan. If they do not agree, there would still be time to compromise, but the risks that Greece will leave the Eurozone will be more likely than not.
How will the Greeks vote on July 5th?
Polls show about 60% of the Greeks would vote in favor of taking the IMF’s deal. However, a lot can change over the course of a week.
If the Greeks vote against the terms, how much time is there for a last minute compromise?
The Greeks would be able to get by until July 20th because they could borrow from the European Central Bank (ECB) until then. OnJuly 20th, they have to pay the ECB 3.5 billion euros. Chancellor Angela Merkel said that Germany (they are running the show behind the scenes) is open to negotiations with Greece “at any time,” which keeps the door open for a compromise over the next three weeks.
Why do I care about Greece?
The Greek economy is relatively insignificant from a global perspective. They are about 1/2 the size of the Ohio economy and a little smaller than Indiana’s economy. The reason people are paying attention to Greece is because they would be the first country to leave the Eurozone. This increases the risk that more important countries like Spain or Italy would leave the Eurozone too. The risk that these countries would leave is low, as the IMF and ECB would likely bend over backwards for them.
What happens if Greece leaves the Eurozone?
If Greece leaves the Eurozone they will have defaulted on their loans. Unlike 2008 or 2011, the global economies are in much better shape to handle this. Back then, a lot of the Greek debt was owned by private banks, but now only 17% of their debt is owned by private institutions. The rest is owned by government entities. If Greece would have defaulted in 2011, banks would have had to write down loans and many might have gone under water. Since banks don’t own much of the debt today, the risk of widespread bank closures is low.
The Eurozone would actually end up being stronger if Greece leaves because Greece is the weakest link. From a fundamental perspective, things are improving in Europe as their economy grew 1% in the first quarter (much better than expected) and their unemployment rate is at a 3-year low. But the real problem is that a Greece exit (known as a Grexit) becomes a chink in the armor that is the euro currency.
Greece would likely fall into a deep recession as they begin the messy process of switching currencies from the euro to the drachma. However, they would eventually be able to return to growth without the constraints enforced on them.
Will the euro currency collapse?
Greece leaving should not cause the euro to collapse. The risk of the euro collapsing would occur if Spain or Italy would decide to leave the Eurozone. That is a very low risk occurrence at this point.
For more, see Simply Money Advisors
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