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Europe Pressuring Tsipras to Make Move…

Greece’s creditors turned up the heat on Prime Minister Alexis Tsipras to come up with a plan to stay in the euro, as banknotes become more scarce and the nation stares at an economic calamity.

After voters emphatically endorsed Tsipras’s call for a “no” to more austerity in Sunday’s referendum, European finance ministers are waiting for a proposal to re-start bailout talks. In a bid to speed the process, Greek Finance Minister Yanis Varoufakis said he was stepping down after more than five months of confrontation.

The onus is on Greece to act quickly to avoid a meltdown of its banking industry. A week of capital controls is set to be extended, while the cash machines that have money are running short of notes and pensions are rationed. German Chancellor Angela Merkel and French President Francois Hollande are due to meet other euro-region leaders tomorrow as the crisis escalates while the European Central Bank is also evaluating its next moves to keep the country afloat.

“Time is running out and the window for a deal keeps narrowing,” Mujtaba Rahman, head of the Europe practice at Eurasia Group in London, wrote in a note to clients. “The euro leaders’ summit on Tuesday is likely to prove decisive for Greece’s euro membership.”

Merkel’s chief spokesman, Steffen Seibert, said no resolution was imminent. A deal within 48 hours will be “difficult to achieve,” he said.

“In the next couple of days we’ll see whether there is sufficient trust and the political opportunity to find a solution,” Jeroen Dijsselbloem, president of the group of euro-region finance ministers, told reporters in The Hague. “That has to be looked at. It’s not so easy to close a door.”

Varoufakis said his departure was intended to bolster Greece’s position after a larger-than-forecast 61 percent of voters rejected further austerity. The motorbike-riding economics professor had sparred openly with counterparts including Wolfgang Schaeuble of Germany.

He is being replaced by Deputy Foreign Minister Euclid Tsakalotos, Skai television reported. Tsipras has involved Tsakalotos, a trusted party hand, in negotiations recently as Varoufakis took more of a back seat.

MARKET REACTION
Greece Seen 48 Hours Away From Unrest
By Will Wainewright, Bloomberg News

Greek Prime Minister Alexis Tsipras probably has 48 hours to resolve a standoff with creditors before civil unrest breaks out and ATMs run out of cash, hedge fund Balyasny Asset Management said.

Fund managers are questioning how the International Monetary Fund and Europe’s leaders can seal a deal with Athens following the “no” vote in a Greek referendum on Sunday.

“I don’t see a good resolution any time soon,” Colin Lancaster, senior managing director with Balyasny, a $9 billion fund based in Chicago, said in an e-mailed statement. “The big question is whether the EU adopts a strategy of waiting them out. The hope would be that the unrest leads to a unity government or change in government.”

Hedge fund managers turned cautious on global equities in the run-up to Sunday’s vote, with sales of stocks sending a gauge of manager bullishness sliding. The Evercore ISI index of hedge fund long versus short bets was at 50.5 in the week ending July 1, down from 51.8 at the start of June, data from the New York-based research firm show.

The survey, based on 31 hedge funds with about $86 billion under management, tracks investments on a zero through 100 scale. Readings of zero show “maximum” short selling, or the sale of borrowed equities with the hope of profiting by buying them at lower prices later; 100 means “maximum” bullish bets. The index has dipped below 50 only twice in the past year.

How Bad Is ‘No’ for Greek Banks? Analysts Split
By Fabio Benedetti-Valentini and Ambereen Choudhury, Bloomberg News

Greece’s “no” vote, rejecting further austerity demanded by creditors, left analysts and financial researchers rushing to predict whether the European Central Bank will continue providing the nation’s banks with aid — and what will happen without it. Below are excerpts from research notes and interviews:

Diego Iscaro, senior economist at IHS Global Insight in London:“We expect the central bank to continue providing liquidity to Greece’s financial sector, although the small chance of the ECB increasing the cap on the Emergency Liquidity Assistance this week has disappeared with the referendum result… We estimate it is very likely banks will not reopen on 7 July as currently expected. Moreover, the limit on bank withdrawals, currently at 60 euros ($66), may also need to be reduced.”

Barclays economics research, led by Francois Cabau, referring to the ECB’s general council: “We would expect ECB’s GC to shut down ELA at the latest by 20 July. Assuming that all of the pledged collateral at the ECB is recorded at (close to) par on Greek banks’ balance sheets and that current average haircut on collateral is 50 percent, then retention of the collateral by the euro system would translate into a more than 30 billion-euro loss for the banks. This alone would wipe out shareholders’ equity. The Greek central bank will eventually need to print its own currency in order to inject new liquidity and capital.”

Citigroup Inc. European banking analysts, led by Ronit Ghose: “We estimate about 150 million euros to 250 million euros has left the banks daily in ATM withdrawals post capital controls were announced last Monday. At the current rate, Greek banks could run out of cash by the middle of the coming week… In the context of Grexit, a full nationalization is likely.”

Roy Smith, finance professor at New York University’s Stern School of Business: “The ECB may not want to see the Greek banking system go down in flames overnight — before some sort of smoothing exit arrangements can be made that could enable Greece to have a decent survival chance outside the euro. Maybe a 30-day line of credit to enable the banks to reopen, and to see for sure whether Greece is going to leave the euro or not. I don’t see how the troika can continue to work with Greece, but I do see a willingness to help them leave as gracefully as possible.”

Greek Vote Greeks Say ‘No’, Grexit Door Opening

Greek citizens clearly said “no” to the creditors’ latest proposals at Sunday’s referendum. Greece’s future in the euro area has become less certain and the nation is now as likely to leave as to stay. While both sides will probably at least agree to reconvene talks, it is hard to see how a deal could easily be reached in this context. Banks are unlikely to reopen on Tuesday.

With a clear victory for the “no” camp suggested by the official results, Prime Minister Alexis Tsipras — who campaigned for “no” — is likely to publicly ask creditors to restart negotiations as soon as possible. Greek authorities are likely to adopt an even less conciliatory stance — especially with the wide margin between the “no” and “yes” sides (61 percent to 39 percent) — and exasperation and fatigue are already running high on the other side of the table after five months of fruitless negotiations.

To complicate things even more, the bailout-extension offer that Greek citizens rejected was no longer available in any case, since the bailout ended on Tuesday. A new bailout will have to be negotiated. This is a lengthy and risky process. For example, the German Bundestag first has to authorize the German government to enter into negotiations that might create new liabilities for the European Stability Mechanism. And even if a deal is reached, the validation process carries significant risks at the national level of the 18 other euro-area members.

Negotiations will need time but the Greek economy is already in a critical condition, held in stasis by capital controls and bank holidays. The cash-strapped state needs fresh money to pay wages, pensions and meet its financial obligations. Also, bank ATMs are reported to be running out of money with scared depositors queuing to withdraw their cash. The ECB has decided to not shut down the ELA facility but has stopped raising the ceiling in recent days. Central bankers meet today again. On Friday, ECB Vice-President Vitor Constancio warned that the referendum result “will have to enter into our analysis of the situation of the Greek banks” since “it affects the probability of agreements” at a political level. The “no” victory in Sunday’s vote is likely to push central bankers out of their patient stance. A tightening of collateral requirements to tap the ELA facility could suddenly look like a reasonable intermediate step before an outright shutdown for many members of the Governing Council. Banks are therefore likely to remain close tomorrow.

Even if the situation is more messy and uncertain than before the vote, an exit from the currency union wouldn’t happen overnight. One must remember that it has never happened before and there is no established process in the European treaties. If new negotiations were to fail, the Greek authorities would have no mandate to take the country out of the currency area. Sunday’s question wasn’t an “in or out” one. A new vote could give Tsipras a mandate for Grexit, but Greeks would probably use it to say no. According to a Bloomberg poll conducted this week, 81 percent of Greek citizens want to keep the euro.

Greek citizens clearly said “no” to the creditors’ latest proposals at Sunday’s referendum. Greece’s future in the euro area has become less certain and the nation is now as likely to leave as to stay. While both sides will probably at least agree to reconvene talks, it is hard to see how a deal could easily be reached in this context. Banks are unlikely to reopen on Tuesday.

With a clear victory for the “no” camp suggested by the official results, Prime Minister Alexis Tsipras — who campaigned for “no” — is likely to publicly ask creditors to restart negotiations as soon as possible. Greek authorities are likely to adopt an even less conciliatory stance — especially with the wide margin between the “no” and “yes” sides (61 percent to 39 percent) — and exasperation and fatigue are already running high on the other side of the table after five months of fruitless negotiations.

To complicate things even more, the bailout-extension offer that Greek citizens rejected was no longer available in any case, since the bailout ended on Tuesday. A new bailout will have to be negotiated. This is a lengthy and risky process. For example, the German Bundestag first has to authorize the German government to enter into negotiations that might create new liabilities for the European Stability Mechanism. And even if a deal is reached, the validation process carries significant risks at the national level of the 18 other euro-area members.

Negotiations will need time but the Greek economy is already in a critical condition, held in stasis by capital controls and bank holidays. The cash-strapped state needs fresh money to pay wages, pensions and meet its financial obligations. Also, bank ATMs are reported to be running out of money with scared depositors queuing to withdraw their cash. The ECB has decided to not shut

Greece Takes the ‘No’ Path

down the ELA facility but has stopped raising the ceiling in recent days. Central bankers meet today again. On Friday, ECB Vice-President Vitor Constancio warned that the referendum result “will have to enter into our analysis of the situation of the Greek banks” since “it affects the probability of agreements” at a political level. The “no” victory in Sunday’s vote is likely to push central bankers out of their patient stance. A tightening of collateral requirements to tap the ELA facility could suddenly look like a reasonable intermediate step before an outright shutdown for many members of the Governing Council. Banks are therefore likely to remain close tomorrow.

Even if the situation is more messy and uncertain than before the vote, an exit from the currency union wouldn’t happen overnight. One must remember that it has never happened before and there is no established process in the European treaties. If new negotiations were to fail, the Greek authorities would have no mandate to take the country out of the currency area. Sunday’s question wasn’t an “in or out” one. A new vote could give Tsipras a mandate for Grexit, but Greeks would probably use it to say no. According to a Bloomberg poll conducted this week, 81 percent of Greek citizens want to keep the euro.

CommentaryTen Consequences of Greece’s ‘No’

By heeding their government’s advice and voting “No” in the referendum on Sunday, Greek citizens sent an unambiguous message. Much like the fictional Americans portrayed in the movie “Network” who threw open their windows and shouted out, “I’m as mad as hell and I’m not going to take this anymore,” the Greeks are demanding that the rest of Europe acknowledge their distress.

At this stage, however, only a handful of European leaders seem willing to listen; and even fewer appear willing to deliver the sort of relief that Greece desperately needs. The implications will be felt primarily in Greece, but also in Europe and beyond.

Here are 10 consequences of the vote that could unfold in the next few days:

  1. The victory of the “No” camp — with more than 60 percent of the vote, according to preliminary returns — will initially lead to a general selloff in global equities, along with price pressures on the bonds issued by Greece, other peripheral euro zone economies and emerging markets. German and U.S. government bonds will benefit from a flight to quality.
  2. Having been caught off guard, European politicians will urgently seek to regain the initiative: Chancellor Angela Merkel of Germany and President Francois Hollande of France will meet in Paris on Monday to work on a response. In a perfect world, these leaders would move quickly and effectively with the Greek government to get past the conflict and acrimony that preceded the referendum. This is likely to be difficult, given the mistrust, bad blood and damaging accusations that have poisoned the relationship.
  3. Even with those challenges, Greek and European politicians don’t have much time to get their act together. The horrid conditions in Greece will get a lot worse before they improve. Without huge emergency assistance from the European Central Bank — a decision that faces long odds — the government will find it hard to get money to the country’s automated teller machines, let alone re-open the banks.
  4. As hoarding increases, shortages of goods, including fuel and food, will intensify. Capital and payments controls will be tightened. The economy will take another worrisome step down, worsening unemployment and poverty. And the government will struggle to pay pensioners and the salaries of civil servants.
  5. As a result, the government will be under mounting pressure to issue some type of IOUs to maintain a sense of a functioning economy. If it does, the IOUs will take on the role of a parallel currency, quoted domestically at a discount to the single currency.
  6. Outside Greece, a lot of thought will be given to limiting adverse spillovers. The ECB will most likely have to roll out new measures to contain regional contagion, including expanding the current program of large-scale purchases of securities. This will weaken the euro’s exchange rate. In addition, together with the IMF — to which Greece is already in arrears — officials will be preparing for serial Greek defaults.
  7. All parties involved will find themselves slipping into their Plan B mode. This transition will probably be much more traumatic for Greece than for the rest of Europe.
  8. With the ultimate goal of countering as quickly as possible the likelihood of further human suffering, pain and uncertainty, Europe has the instruments and institutions to limit contagion and maintain the integrity of the euro zone. But this will require ECB action to be coupled with measures by the European Stability Mechanism and the European Investment Bank aimed at completing a banking union and making progress on fiscal integration.
  9. It is quite doubtful, however, that Greece will be able to restore its status as a full member of the euro zone. Indeed, without very skillful crisis management, it is at high risk of becoming a failed state. Rather than just stand by, Europe needs to ensure that Greece’s exit from the 19-member euro zone doesn’t also result in its dissociation from the larger European Union. This could involve special membership in an association agreement, for example,
  10. Finally, expect an explosion of blame. This unproductive activity may end up delaying Europe’s urgent need to internalize the lessons from this sad outcome: A series of broken reform promises by several Greek governments was made worse by political stubbornness, poor analysis and inconsistent follow-through by Europe, which is contributing to the loss of Greece as a functioning member of the family.

By heeding their government’s advice and voting “No” in the referendum on Sunday, Greek citizens sent an unambiguous message. Much like the fictional Americans portrayed in the movie “Network” who threw open their windows and shouted out, “I’m as mad as hell and I’m not going to take this anymore,” the Greeks are demanding that the rest of Europe acknowledge their distress.

At this stage, however, only a handful of European leaders seem willing to listen; and even fewer appear willing to deliver the sort of relief that Greece desperately needs. The implications will be felt primarily in Greece, but also in Europe and beyond.

Here are 10 consequences of the vote that could unfold in the next few days:

  1. The victory of the “No” camp — with more than 60 percent of the vote, according to preliminary returns — will initially lead to a general selloff in global equities, along with price pressures on the bonds issued by Greece, other peripheral euro zone economies and emerging markets. German and U.S. government bonds will benefit from a flight to quality.
  2. Having been caught off guard, European politicians will urgently seek to regain the initiative: Chancellor Angela Merkel of Germany and President Francois Hollande of France will meet in Paris on Monday to work on a response. In a perfect world, these leaders would move quickly and effectively with the Greek government to get past the conflict and acrimony that preceded the referendum. This is likely to be difficult, given the mistrust, bad blood and damaging accusations that have poisoned the relationship.
  3. Even with those challenges, Greek and European politicians don’t have much time to get their act together. The horrid conditions in Greece will get a lot worse before they improve. Without huge emergency assistance from the European Central Bank — a decision that faces long odds — the government will find it hard to get money to the country’s automated teller machines, let alone re-open the banks.
  4. As hoarding increases, shortages of goods, including fuel and food, will intensify. Capital and payments controls will be tightened. The economy will take another worrisome step down, worsening unemployment and poverty. And the government will struggle to pay pensioners and the salaries of civil servants.
  5. As a result, the government will be under mounting pressure to issue some type of IOUs to maintain a sense of a functioning economy. If it does, the IOUs will take on the role of a parallel currency, quoted domestically at a discount to the single currency.
  6. Outside Greece, a lot of thought will be given to limiting adverse spillovers. The ECB will most likely have to roll out new measures to contain regional contagion, including expanding the current program of large-scale purchases of securities. This will weaken the euro’s exchange rate. In addition, together with the IMF — to which Greece is already in arrears — officials will be preparing for serial Greek defaults.
  7. All parties involved will find themselves slipping into their Plan B mode. This transition will probably be much more traumatic for Greece than for the rest of Europe.
  8. With the ultimate goal of countering as quickly as possible the likelihood of further human suffering, pain and uncertainty, Europe has the instruments and institutions to limit contagion and maintain the integrity of the euro zone. But this will require ECB action to be coupled with measures by the European Stability Mechanism and the European Investment Bank aimed at completing a banking union and making progress on fiscal integration.
  9. It is quite doubtful, however, that Greece will be able to restore its status as a full member of the euro zone. Indeed, without very skillful crisis management, it is at high risk of becoming a failed state. Rather than just stand by, Europe needs to ensure that Greece’s exit from the 19-member euro zone doesn’t also result in its dissociation from the larger European Union. This could involve special membership in an association agreement, for example,
  10. Finally, expect an explosion of blame. This unproductive activity may end up delaying Europe’s urgent need to internalize the lessons from this sad outcome: A series of broken reform promises by several Greek governments was made worse by political stubbornness, poor analysis and inconsistent follow-through by Europe, which is contributing to the loss of Greece as a functioning member of the family. 

The Messy Future of a Post-Euro Greece

Introducing a new currency is no small feat. Recent cases — East Germany’s adoption of the deutsche mark, the Czech-Slovak divorce of 1993, and the creation of the euro itself — benefited from years of careful planning and broad popular support. If Greece were to abandon the euro, it would have neither.

“Historical precedent suggests this would be hugely challenging,” said Richard Portes, a professor of economics at London Business School. “The situation in Greece is perhaps even worse because it’s not clear that they have the administrative capacity to move quickly to a new currency.”

Greece’s government said it intends to keep the euro even if voters reject the terms of a proposed international bailout in the referendum. While a poll commissioned this week by Bloomberg found the vote too close to call, it showed that 81 percent of Greeks want their country to remain in the euro zone.

Many economists, though, say that would be difficult after a “no” vote — even if in the long run the country might benefit from such a shift. The Greek banking system is dependent on support from the European Central Bank, which might be withdrawn in that event. That could force Greece to create its own means of exchange — a new drachma — to keep its economy running.

Countries switching currencies must grapple with two major questions: how to introduce new notes and coins, and what to do with bank accounts, debts, and financial instruments denominated in the old currency.

National Business Card

The former is relatively straightforward. The Greek central bank owns a press in the Athens suburb of Holargos that prints euro notes. That plant printed Greece’s pre-euro drachma, and could make a new drachma, too.

“A currency is a national business card, so you want to make it right,” said Ralf Wintergerst, head of banknote production at Giesecke & Devrient GmbH, a Munich company that has printed banknotes since the days of Germany’s Reichsmark in the 1920s.

Wintergerst says introducing a new currency typically takes at least six months, and sometimes as long as two years. Artists must draw the notes, security experts then add anti-counterfeit measures such as watermarks and special inks, and bank officials need to plan how much of each denomination is needed and get the money to banks.

Difficult Distribution

“The most challenging thing was to establish efficient distribution and make sure the new currency was available everywhere,” said Boris Raguz, head of the Treasury Directory at Croatia’s central bank, who in 1993 oversaw the introduction of the country’s currency, the kuna, after the breakup of Yugoslavia.

Greater difficulties arise when banks start issuing that money. Because of the time required to distribute new notes and coins, the two currencies have to exist side by side for some time. While Greek banks might move card transactions to the new drachma immediately, shops could accept both — or perhaps only euros if merchants doubted the value of the new drachma.

“When will the conversion happen? At what rate?” said Antonio Fatas, a professor of economics at Insead business school near Paris. “That’s the big question.”

The two currencies would likely start at a one-to-one exchange rate, which might be fixed for a period of time. The euro was created in 1999, but it existed only virtually for three years, used for electronic transactions at a rate fixed

against the francs, marks, and other currencies it replaced. Then on Jan. 1, 2002, euro bills and coins were introduced, though the old currencies were also accepted for about two more months.

Little Planning

Greece would be more complicated because the transition would have to happen fast, with little planning. And unlike most other currencies that have been abandoned, Greece’s current currency — the euro — will remain in circulation across Europe no matter what. That means any new currency might have little appeal to Greeks, who would expect its value to fall once the market was allowed to set the exchange rate.

“As soon as anyone got new drachmas stuffed in their pockets, they would do whatever it takes to get rid of them,” said Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington.

Trust Is Key

Another complication, according to Kirkegaard, is that Greece’s many importers might demand to be paid in euros, rather than depreciating drachmas that would do little to meet their international costs.

Ludek Niedermayer, who headed the risk management department at the Czech central bank when the Czech koruna was introduced in February 1993, said that at the time his country and Slovakia were relatively isolated, having emerged from communism less than four years earlier. Greece, he noted, is far more integrated into the European economy, making it harder to switch.

The key is trust in the new currency, Niedermayer said. That’s something the Czechs and Slovaks both had, and which the Greeks will surely lack.

“If you introduce a currency that no one wants, it’s a very bad start,” Niedermayer said. “I would advise Greeks to stop thinking about leaving the euro at all. It wouldn’t be a happy ending for them. There isn’t any alternative that would be equal to having the euro.”

Introducing a new currency is no small feat. Recent cases — East Germany’s adoption of the deutsche mark, the Czech-Slovak divorce of 1993, and the creation of the euro itself — benefited from years of careful planning and broad popular support. If Greece were to abandon the euro, it would have neither.

“Historical precedent suggests this would be hugely challenging,” said Richard Portes, a professor of economics at London Business School. “The situation in Greece is perhaps even worse because it’s not clear that they have the administrative capacity to move quickly to a new currency.”

Greece’s government said it intends to keep the euro even if voters reject the terms of a proposed international bailout in the referendum. While a poll commissioned this week by Bloomberg found the vote too close to call, it showed that 81 percent of Greeks want their country to remain in the euro zone.

Many economists, though, say that would be difficult after a “no” vote — even if in the long run the country might benefit from such a shift. The Greek banking system is dependent on support from the European Central Bank, which might be withdrawn in that event. That could force Greece to create its own means of exchange — a new drachma — to keep its economy running.

Countries switching currencies must grapple with two major questions: how to introduce new notes and coins, and what to do with bank accounts, debts, and financial instruments denominated in the old currency.

National Business Card

The former is relatively straightforward. The Greek central bank owns a press in the Athens suburb of Holargos that prints euro notes. That plant printed Greece’s pre-euro drachma, and could make a new drachma, too.

“A currency is a national business card, so you want to make it right,” said Ralf Wintergerst, head of banknote production at Giesecke & Devrient GmbH, a Munich company that has printed banknotes since the days of Germany’s Reichsmark in the 1920s.

Wintergerst says introducing a new currency typically takes at least six months, and sometimes as long as two years. Artists must draw the notes, security experts then add anti-counterfeit measures such as watermarks and special inks, and bank officials need to plan how much of each denomination is needed and get the money to banks.

Difficult Distribution

“The most challenging thing was to establish efficient distribution and make sure the new currency was available everywhere,” said Boris Raguz, head of the Treasury Directory at Croatia’s central bank, who in 1993 oversaw the introduction of the country’s currency, the kuna, after the breakup of Yugoslavia.

Greater difficulties arise when banks start issuing that money. Because of the time required to distribute new notes and coins, the two currencies have to exist side by side for some time. While Greek banks might move card transactions to the new drachma immediately, shops could accept both — or perhaps only euros if merchants doubted the value of the new drachma.

“When will the conversion happen? At what rate?” said Antonio Fatas, a professor of economics at Insead business school near Paris. “That’s the big question.”

The two currencies would likely start at a one-to-one exchange rate, which might be fixed for a period of time. The euro was created in 1999, but it existed only virtually for three years, used for electronic transactions at a rate fixed

against the francs, marks, and other

currencies it replaced. Then on Jan. 1, 2002, euro bills and coins were introduced, though the old currencies were also accepted for about two more months.

Little Planning

Greece would be more complicated because the transition would have to happen fast, with little planning. And unlike most other currencies that have been abandoned, Greece’s current currency — the euro — will remain in circulation across Europe no matter what. That means any new currency might have little appeal to Greeks, who would expect its value to fall once the market was allowed to set the exchange rate.

“As soon as anyone got new drachmas stuffed in their pockets, they would do whatever it takes to get rid of them,” said Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington.

Trust Is Key

Another complication, according to Kirkegaard, is that Greece’s many importers might demand to be paid in euros, rather than depreciating drachmas that would do little to meet their international costs.

Ludek Niedermayer, who headed the risk management department at the Czech central bank when the Czech koruna was introduced in February 1993, said that at the time his country and Slovakia were relatively isolated, having emerged from communism less than four years earlier. Greece, he noted, is far more integrated into the European economy, making it harder to switch.

The key is trust in the new currency, Niedermayer said. That’s something the Czechs and Slovaks both had, and which the Greeks will surely lack.

“If you introduce a currency that no one wants, it’s a very bad start,” Niedermayer said. “I would advise Greeks to stop thinking about leaving the euro at all. It wouldn’t be a happy ending for them. There isn’t any alternative that would be equal to having the euro.”

Contagion

Why Greek Fallout Remains Contained

The likelihood of a Grexit has increased significantly with the breakdown of talks, bank closures and the referendum on creditor demands. It might be surprising, then, that there was little evidence of contagion to the rest of peripheral Europe last week. Largely, that reflects a backstop provided by the possibility of Outright Monetary Transactions (the European Central Bank’s sterilized intervention program) and the progress that has been made on limiting intra-European exposures.

The outcome of the referendum on creditor demands is hard to predict and even a Yes vote doesn’t guarantee that Greece will stay in the currency union. The rising likelihood of Grexit has prompted discussion of contagion risk and even called into question the viability of the euro itself. Yet there is scant evidence thus far that investors are very concerned.

An obvious place to look for stress is the bond market. The cost of borrowing for periphery nations, relative to rates paid by Germany, has risen only slightly since negotiations broke down in the past week. Compared with the experience of 2011, the movement is barely perceptible (see accompanying chart).

Another place to look is the financial sector. Banks aren’t just exposed to sovereign debt — they have exposures to corporates and households in the European periphery. There was some movement in equity valuations recently but indicators of stress between banks remain calm. To assess that, we look at the spread between interbank borrowing rates and overnight interest rate swaps.

European equities have sold off a bit, but not by nearly enough to unwind the year’s gains. And a good chunk of that could reflect concerns of a global nature – Chinese equities have declined significantly. Perhaps the ultimate diagnostic on contagion risk is the euro itself. The currency has proven remarkably robust to Greek news in recent months and the depreciation since 2014 largely reflects expectations for looser monetary policy.

So what explains it? While some volatility might be expected should the worst happen in Greece, we see five reasons for contagion to be limited.

Above all, if things get nasty, the ECB can always intervene to keep the yields low for Spain, Italy, Portugal and other countries. Draghi’s “whatever it takes” intervention still provides a floor to the value of peripheral sovereign debt. The judgment of the EU Court of Justice confirming the legality of a possible Outright Monetary Transactions program bolsters that support. And maybe the Securities Markets Program could be expanded if things get desperate.

Greece is unusual. The other peripheral nations carry a smaller debt burden and the politics are different — there’s a smaller risk of a party like Syriza coming to power and for negotiations with creditors to go so badly.

If Greece does leave, it’s going to be so horrible for the first year or so that nobody else will fancy taking that path.

The banks have very little exposure to Greece — almost all of the public debt is on the Eurogroup and ECB balance sheets. The creation of a single supervisory and resolution mechanism for banks helps separate them from sovereigns.

The latest developments in Greece are happening in the context of the ECB’s quantitative easing program. That is suppressing yields by creating substantial demand for debt issued by all euro-area governments, and purchases are accelerating ahead of the summer lull.

The likelihood of a Grexit has increased significantly with the breakdown of talks, bank closures and the referendum on creditor demands. It might be surprising, then, that there was little evidence of contagion to the rest of peripheral Europe last week. Largely, that reflects a backstop provided by the possibility of Outright Monetary Transactions (the European Central Bank’s sterilized intervention program) and the progress that has been made on limiting intra-European exposures.

The outcome of the referendum on creditor demands is hard to predict and even a Yes vote doesn’t guarantee that Greece will stay in the currency union. The rising likelihood of Grexit has prompted discussion of contagion risk and even called into question the viability of the euro itself. Yet there is scant evidence thus far that investors are very concerned.

An obvious place to look for stress is the bond market. The cost of borrowing for periphery nations, relative to rates paid by Germany, has risen only slightly since negotiations broke down in the past week. Compared with the experience of 2011, the movement is barely perceptible (see accompanying chart).

Another place to look is the financial sector. Banks aren’t just exposed to sovereign debt — they have exposures to corporates and households in the European periphery. There was some movement in equity valuations recently but indicators of stress between banks remain calm. To assess that, we look at the spread between interbank borrowing rates and overnight interest rate swaps.

European equities have sold off a bit, but not by nearly enough to unwind the year’s gains. And a good chunk of that could reflect concerns of a global nature – Chinese equities have declined significantly. Perhaps the ultimate diagnostic on contagion risk is the euro Peripheral Bonds Insulated From Greek Volatility itself. The currency has proven remarkably robust to Greek news in recent months and the depreciation since 2014 largely reflects expectations for looser monetary policy.

So what explains it? While some volatility might be expected should the worst happen in Greece, we see five reasons for contagion to be limited. Above all, if things get nasty, the ECB can always intervene to keep the yields low for Spain, Italy, Portugal and other countries. Draghi’s “whatever it takes” intervention still provides a floor to the value of peripheral sovereign debt. The judgment of the EU Court of Justice confirming the legality of a possible Outright Monetary Transactions program bolsters that support. And maybe the Securities Markets Program could be expanded if things get desperate.

Greece is unusual. The other peripheral nations carry a smaller debt burden and the politics are different — there’s a smaller risk of a party like Syriza coming to power and for negotiations with creditors to go so badly.

If Greece does leave, it’s going to be so horrible for the first year or so that nobody else will fancy taking that path.

The banks have very little exposure to Greece — almost all of the public debt is on the Eurogroup and ECB balance sheets. The creation of a single supervisory and resolution mechanism for banks helps separate them from sovereigns.

The latest developments in Greece are happening in the context of the ECB’s quantitative easing program. That is suppressing yields by creating substantial demand for debt issued by all euro-area governments, and purchases are accelerating ahead of the summer lull. Source: Bloomberg