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Saturday, January 03, 2015 4:35 PM

Competing Views: Grexit Would Be "Lehman Squared" vs. No Problem; Where to Point the Finger When it Blows

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There's an amusing pair of headlines back-to-back today on what a Greek exit from the Eurozone might mean.

 One view is catastrophic, the other is along the lines of no problem. Let's start with the catastrophe.

Economic historian Barry Eichengreen says Greek Euro Exit Would be ‘Lehman Brothers Squared.

A decision by a new Greek government to leave the eurozone would set off devastating turmoil in financial markets even worse than the collapse of Lehman Brothers in 2008, a leading international economist warned Saturday.

A Greek exit would likely spark runs on Greek banks and the country’s stock market and end with the imposition of severe capital controls, said , an economic historian at the University of California at Berkeley. He spoke as part of a panel discussion on the euro crisis at the American Economic Association’s annual meeting.

The exit would also spill into other countries as investors speculate about which might be next to leave the currency union, he said.

“In the short run, it would be Lehman Brothers squared,” Eichengreen warned.

Martin Feldstein [professor of economics at Harvard University], a longtime critic of the euro project, said all the attempts to return Europe to healthy growth have failed.

“I think there may be no way to end to euro crisis,” Feldstein said.

The options being discussed to stem the crisis, including launch of full scale quantitative easing by the European Central Bank, “are in my judgment not likely to be any more successful,” Feldstein said.

The best way to ensure the euro’s survival would be for each individual eurozone member state to enact its own tax policies to spur demand, including cutting the value-added tax for the next five years to increase consumer spending, Feldstein said.

He predicted that European politicians would “swallow hard once again” and make the compromises necessary to keep Greece in the currency union.

“While holding the eurozone together will be costly and difficult and painful for the politicians, breaking it up will be even more costly and more difficult,” he said.
Limited Contagion Thesis

Yahoo!Finance reports Germany Believes Eurozone Could Cope with Greece Exit.
The German government believes that the euro zone would now be able to cope with a Greece exit if that proved to be necessary, Der Spiegel news magazine reported on Saturday, citing unnamed government sources.

Both Chancellor Angela Merkel and Finance Minister Wolfgang Schaeuble believe the euro zone has implemented enough reforms since the height of the regional crisis in 2012 to make a potential Greece exit manageable, Der Spiegel reported.

"The danger of contagion is limited because Portugal and Ireland are considered rehabilitated," the weekly news magazine quoted one government source saying.

In addition, the European Stability Mechanism (ESM), the euro zone's bailout fund, is an "effective" rescue mechanism and was now available, another source added. Major banks would be protected by the banking union.

According to the report, the German government considers a Greece exit almost unavoidable if the leftwing Syriza opposition party led by Alexis Tsipras wins an election set for Jan. 25.
Competing Views on Funding Needs

Before taking a side in the above debate, let's take a look at competing views on Greek funding needs. Please consider a snip from SYRIZA Makes Fresh Pledge to Defend Greek Capitalism.
Analysts at Bank of America Merill Lynch, “think Tsipras will face a budget black hole of at least 28 billion euros in the first two years of his government, with nowhere to borrow from and 17 billion euros of repayments to make in the first year.
In contrast, the Wall Street Journal reports Greece Expects Primary Budget Surplus for 2015.
Greece’s 2015 budget, submitted by the government to parliament on Friday, aims to meet the fiscal demands of the country’s creditors but comes without the prior approval of its troika of international inspectors.

According to the budget, Greece will achieve a primary budget surplus—before taking into account debt payments—of €3.3 billion ($4.1 billion), equal to 3% of gross domestic product, next year, which is in line with the country’s bailout program.

Overall, the government will record only a minor budget deficit of €338 million—equivalent to just 0.2% of gross domestic product—next year, in effect marking the first balanced budget Greece has produced in four decades.

Despite surpassing its budget targets for three years running, Greece is at loggerheads with the troika—made up of representatives from the European Commission, the International Monetary Fund and the European Central Bank—over further fiscal measures the country must take, as well as a number of promised overhauls.
Primary Account Surplus or Not?

Does Greece have a €28 billion black hole or a surplus?

Both can technically be true. The €28 black hole counts interest on debt including the €245 bailout package. The primary surplus theory ignores interest on the debt.

If the Troika suspends the bailout, then Greece will have no choice but to default. Of course, that points to the absurdity of the alleged bailout setup in the first place.

Even if the interest rate on the bailout was 0%, with a €3 billion surplus every year, it would take Greece 81 years to pay back that debt!

Economic Reality

There is no realistic way Greece can ever pay back €245 billion, so it won't.

With that thought, let's return to the first question. Would a Greece exit be "Lehman Squared" or would it have little effect?

Actually, no matter what happens with Greece, the entire eurozone setup is unstable. Greece, Spain, Italy, and Portugal all are in impossible payback setups. Even if Syriza loses the next election, sooner or later Greece, Spain, Italy, or possibly even France will exit the eurozone.

The "limited contagion" view is complete nonsense. The eurozone debt problem is going to explode, and whether or not it becomes "Lehman Squared" depends on the response.

My view is the longer the ECB and EU attempt to hold this mess together with no debt writedowns, the bigger the catastrophe.

Greece will not cause a catastrophe, but the EU/ECB handling of a Greece exit is highly likely to do just that.

Eventually, Will Come a Time

As I said in my November 23, 2011 post Eventually, Will Come a Time When ....
Eventually, there will come a time when a populist office-seeker will stand before the voters, hold up a copy of the EU treaty and (correctly) declare all the "bail out" debt foisted on their country to be null and void. That person will be elected.

Le Pen may be too early, and France may not be that country, but the time will come.

Greece, Finland, Germany, Belgium, and even France are possibilities. All it will take, is for one charismatic person, timing social mood correctly, to say precisely one right thing at exactly the right time. It will happen.

  • Greece: Alexis Tsipras - Syriza (Radical Left)
  • France: Marine Le Pen - Front National (Radical Right)
  • Italy: Beppe Grillo - M5S Five Star Movement (Radical Left)
  • Spain: Pablo Iglesias Turrión - Podemos (Radical Left) 

Where to Point the Finger When it Blows

The pot is simmering and is likely to boil over at any time. When it does boil over, Greece will not really be to blame, even if Alexis Tsipras wins the election and carries out his threats.

Rather, be prepared to point the finger at the EU, ECB, and IMF for their collective insistence that Greece, Spain, Italy, etc. repay debt that cannot and will not be paid back.

By the way, there is a small chance Tsipras wins the election and Greece exits the eurozone with limited initial fallout. If so, the major problem will come when Spain or Italy does the same thing.

Mike "Mish" Shedlock

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