Why All Eyes Are on Greece (And Why We Should Care)
While economic data in the U.S. may be mixed, the situation in Europe, and Greece in particular, is not. I’ve been hesitant to write about Greece because it is difficult to add constructively to the volumes already written about the crisis. Nevertheless, as the situation is reaching an inflection point, it is necessary to at least summarize our views.
We know many things: Greece has too much debt, a fragile banking system, poor worker productivity, and overly generous entitlement programs. We also know that the people of Greece don’t like paying taxes, don’t like austerity, and don’t like having their standard of living eroded. Furthermore, we know that Greece imports almost everything it needs because it has no energy reserves, little arable land, and a very small manufacturing base. In addition, many banks outside of Greece are fragile, have too much leverage, and cannot afford to write down the value of the Greek paper they hold lest they be declared insolvent.
It is important to note that Greece’s solvency crisis cannot be resolved by lending the country more, no matter how favorable the terms. It is, therefore, strange that this has been the focus of European policymakers. This is akin to telling a borrower with a $50,000 income that he/she can really afford a $5 million home if we just lower the rate and extend the mortgage out further.
We suspect a good number of things about Greece as well: That it will likely be forced to leave the European Union (EU) and return to the drachma (or some successor currency), and that any new currency is likely to be worth a small fraction of the euro (we estimate a 70 percent devaluation). And if Greece exits the EU, it will likely be forced to self-finance because no one will lend to it. A Greek default will likely trigger a run on other European banks, particularly those in Spain and Italy, starving them of capital and potentially precipitating a liquidity crisis across much of Europe and perhaps in the U.S.
We believe that deflecting a contagious solvency and liquidity crisis in European financials is what has motivated policymakers to extend terms to Greece. It is not because all of Europe is bettered by Greece’s inclusion in the EU. By deferring a Greek default and exit from the EU, policymakers are buying time for the banks to improve their capital positions. Unfortunately, it is not working. Much of Europe is in recession, and stock prices are down sharply, preventing banks from recapitalizing themselves through the equity or debt markets.
It is difficult to imagine a scenario or policy that averts an eventual Greek exit from the EU, though we may just lack a fertile enough imagination. In our view, the best that can be accomplished is an orchestrated exit, with a simultaneous backstopping of the financial system by the European Central Bank. That, however, will require a significantly larger commitment from the disparate parties that make up the EU. The funding mechanisms currently in place lack adequate capital to affect this outcome. As tensions are reaching a peak, saving the eurozone will require greater integration and fiscal solidarity among remaining participants. We remain hopeful that this will be the outcome, even though it will mean hard days ahead for the people of Greece.
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Mark A. Griffin, CIMA®
Principal, Chief Investment Officer
CliftonLarsonAllen Wealth Advisors, LLC (“CLA Wealth Advisors”)
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