“I solve my problems and I see the light…. (Hum along if you know this tune- think John Travolta) There ain't no danger we can go too far, we start believing now that we can be who we are, Greece is the word.” We took some liberty removing the word “Grease” from Frankie Valli’s hit song from the 1978 film of the same name. Inserting the country “Greece” in its place, we made the lyrics out to be more prophetic than Frankie intended. Still, by all accounts, Greece is “the word” as far as the markets are concerned: on June 30 the Greek government—not happy with the latest round of talks—failed to make a relatively small payment to the International Monetary Fund (IMF), in what appears to be a game of financial and political brinksmanship.
For those of you who are less familiar with the background, here is a quick summary: in 2009 Greece revealed that its national finances had been falsified, raising doubts about its ability to repay its debts. Over the next few years Greece received several bailout loans from the European Central Bank, the European Commission, and the IMF (the “Troika”) and Greece was required to fulfill certain conditions intended to improve its financial position. Greek elections subsequently brought in a new government that opposes the stringent conditions. The Greek government has been pushing for greater concessions ever since, but the Troika and other European Union members have been unwilling to show signs of softness.
Prior to this week’s payment deadline, Greece’s Prime Minister announced that he would put the latest debt repayment offer to the Greek populous in a referendum and subsequently urged them to vote “No”. The referendum—to be held on the first weekend of July—is essentially a Yes or No vote on staying in the Euro.
Since the Greeks don’t have any good options, we think it is unlikely that they would want to leave the Euro. Recent polls show the majority of Greeks want to keep the Euro as their currency and remain a part of the European Union, despite the unpopular measures demanded by the Troika. The alternative of exiting the Euro and possibly entering bankruptcy would likely result in conditions that would be equally harsh and unpopular. Neither choice is a good one, and we expect the painful, yet familiar path with the Euro to be more attractive than the painful, yet unknown path without it.
What if we are wrong? Would there be “contagion”? We believe that Europe has made progress in its efforts to limit the damage caused by a potential Greek “exit.” As equity markets fell globally on Greece fears on Monday, we observed several signs that support our view. Although the Euro initially dropped against the US dollar by 2%, it then rallied against the dollar, ending the day stronger. While yields on Italian and Spanish bonds rose on Monday (showing a rise in concern), the moves were modest. Additionally, their yields reflect no greater risk than of default than do US yields, which is a significant change from the peak of the Euro-crisis in 2012 when Italian and Spanish bonds yielded upwards of 7%. This lack of “contagion” is a positive sign for investors, while it takes away some of the leverage the Greek government was hoping to apply in order to receive more favorable terms.
So it would appear that our little Greek musical is more of a Greek tragedy. The Greeks really cannot afford to exit the Euro, and any economic fallout of an exit does seem to be limited. However, it’s still a catchy tune, “….Greece is the word”.