Why Stability Stalwart Singapore Should Be Seriously Scared If The Feta Is Truly Accompli

Tyler Durden's picture

We have discussed the probability (around 50%) and possibility of a Greek exit from the Euro ad nauseum; how the post-election anti-austerity rage is bringing the world to a new realization that this is probable not possible and the widespread risk aversion of this event is much more of a global event than local - no matter how many times you are told how small Greece is. Critically, as BofAML notes, it is the systemic threat of an untamed banking and sovereign crisis in Europe which makes multiple-sigma events less 'tail' and more 'normal'. With money due to run out at the latest by July, new elections mid-June (that show massive support for the anti-bailout party), and the impacts on the real economy, exchange rate and inflation fears, and default and ECB balance sheet implications; it seems there are also strong incentives to keep Greece in. However, there is a political line of compromise and austerity that will be hard to cross for both parties which, if it failed - and it doesn't have much time - would mean a very fast 'ring-fencing' would need to occur for this not to thermonuclear with the three main channels of volatility transmission to the rest of the world being: banking and finance, trade, and confidence - all three of which are active already with Asian trade (and banking exposure) seemingly under-appreciated in our view with Singapore dramatically exposed with a stunning 60%-plus of GDP tied up in European bank claims.

Widespread risk aversion linked to fears of a Greek euro exit underscores the global nature of the European crisis. As we argued in the new year, the systemic threat of an untamed banking and sovereign crisis in Europe would push reluctant outsiders to preventively bolster IMF funding. This indeed materialized in March. However, both IMF and European firewalls still fall short of the amounts needed to protect Italy, Spain and the rest of the periphery. Global markets thus remain sensitive to rising probabilities of tail-risk scenarios. So how would the global economy be affected in the event of a serious adverse shock in Europe?

There are three main channels through which the volatility in Europe could hit the world economy: (i) banking and finance; (ii) trade; and (iii) confidence. These channels have already been active, transmitting the ongoing pull-back in European banks’ international exposure as well as the significant downturn in euro area activity seen since mid-2011. So far the retrenchment of global European banks from emerging markets has proved less disruptive than feared, while the damage to Asian exports appears worse than expected. The trade hit, however, may have been greater in Asia. But the greatest danger remains the threat of a severe blow to global sentiment.


Risk reassessment

The much more significant risk comes if market panic and financial contagion runs ahead of the European response. A sharp withdrawal of reserves from other peripheral countries could lead to global liquidity concerns. European banks pulling out of the US market could be an opportunity for domestic lenders, but in a financial crisis, overall lending is likely to fall. The resulting flight to safety should strengthen the US dollar and push Treasury yields even lower. However, it would almost certainly produce an equity market sell off. More than half of the big moves in the stock market since the end of February have been at least partly the result of events in Europe, and European news looks likely to continue to dominate movements in the US stock market regardless of the resolution to the latest Greek drama. The resulting worsening of financial conditions and softer activity data would likely get the Fed to respond with additional easing, in our view. The key factor would be collateral damage to the US outlook. The Fed knows QE doesn’t do much to help Europe. (For more discussion, see this week’s Fed Watch.) Only a very bad outcome in Europe would be enough to trigger a US recession.

The bigger risk comes year-end, when US fiscal dysfunction will likely have its biggest negative impact on growth. If the US and European crises interact, and feed on one and another, a recession becomes a real risk. This would be a replay of Japan’s experience of the mid-1990s, when a combination of premature fiscal tightening and the Asian crisis triggered a recession and deflation.

Overall, we see about a one-in-three chance of a recession starting sometime in the second half of this year and the first half of next year.

This will be the third year in a row that uncertainty should rule the day in the spring and summer months — and the risk is that, given the fiscal debates in the US and Euro zone, a risk-off environment will drag on further. We foresee at least one more year of living dangerously.

The risks of a Grexit

The recent political paralysis has now brought Greece to what could prove to be the worst stage of its crisis. Following the failure of the elections of May 6, another election has now been called for June 17. The latest polls suggest the risks of a coalition government against the austerity programme, or no agreement on a government at all – are increasing. Although polls in Greece show very strong support for the euro, we believe that the current situation could trigger a chain of events that could lead Greece to exit on its own.

If Greece were to exit, the implications would be profound both for Greece and the Euro area economy. This suggests euro zone policy makers would go a long way to keep Greece in the euro.

Real economy

Although Greece is currently expected to run a primary deficit of 1% in 2012, in the event of a Euro area exit the fiscal contraction would likely be more severe as receipts would fade away as households and corporate try to increase their savings. Consumption and investment would contract sharply. Exports would fall but imports would likely stumble even more. By comparison, when the Czech Republic departed from the Slovak Republic (1991), consumption contracted by 21%, investment 29%, and imports 33%. Overall, GDP contracted nearly 12%.

Greece has never known such a severe contraction. The worst recession was in 1974, when GDP contracted 6.4%. The IMF estimates Greece would go through a 10% GDP contraction in the first year of departure from the euro zone.

Exchange rate and inflation

The same IMF report estimates the real effective exchange rate for Greece could depreciate by 50% before recovering (over the course of four years) to about 85% of its initial level, thus boosting inflation by about 35% in the first year, recovering slowly to below 5% in about 4-5 years.

Default and the ECB

The ECB is exposed to Greece through two channels, repo operations of various maturities and emergency liquidity assistance (ELA). The respective amounts are €109bn and ca. €60bn. Should Greece default, we think it is highly likely that the ECB would terminate the repo operations. And, the ECB could veto the ELA, which would cause the Greek banks to run out of liquidity.

In this case, looking at examples from various emerging market precedents suggests two types of measures may help to avoid a massive run or limit the liquidity crunch: 1) Close exit channels, i.e., ring fencing the banking system, limiting access to cash and prohibiting transfers to foreign banks; and 2) using the central bank, in this case, the Bank of Greece, to provide liquidity by becoming the lender of last resort. That being said, it could also be the case that the ECB decides to keep some liquidity lines open to avoid a bank run (with possible spillovers to other euro periphery countries), or to let Greece pursue ELA under some monitoring.

Finance Private sector balance sheets would be damaged by cross-exposure (which is very difficult to estimate), and then subsequently by inflation. Greek banks, significantly exposed to their sovereign would collapse in the wake of bank runs, the collapse of capital values and not having access to ECB liquidity (see below for a discussion of costs to the private sector in the euro zone).

For the Euro area, we assume that a forceful set of policy measures would be implemented, but they would nevertheless result in elevated costs. Greek assets of around €450bn could also be at risk of significant losses in the immediate aftermath of a Euro exit. In addition, a Greek exit could spill over to other countries, resulting in deposit flights threatening the stability of banking sectors and destabilising sovereign bond markets. As policymakers assess the effect of Greece leaving the euro, the high costs and risk of contagion will, in our view, raise the impetus to keep Greece in.

In our view, the situation in Greece is distinct from elsewhere in the periphery. So while expectations of spillovers may be understandable, they might not be rational. The euro governments may look to use pan euro deposit guarantees and capital injections to contain the potential contagion through the banking sector.

The ECB may commit to provide liquidity to banks and act as a backstop on the sovereign bond markets, provided the Bank was backed by the 16 euro governments.

And The Implications across asset class...

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falak pema's picture

ha, ha, ha , ha....oh, its NOT JUST a Greek problem....well, even the 12 year olds know that! 

onelight's picture

Enter the Facebook billionaires moving to Singapore!

Surely that will fix everything. Nothing to see here, move along.


Rakshas's picture

better to move to vietnam I think....... oh wait ..... the US is making noise about opening bases there again to counter and blunt the chinese claims on the seas from MLC to Singapore...... heard that from one on the mill last month........ what could possibly go wrong with that idea...........

ya know sometimes fucked is just fucked ..........


onelight's picture

Borowitz strikes again: Greece to close/re-open as a social media network, go public to raise new funds


Why not? All the other kids are doing it..

Gully Foyle's picture

Fuck em if you can't see them from Palins Alaska home.

spanish inquisition's picture

Wow, would be nice if they had a citizen that they could tap for a couple of billion to help out.

malikai's picture

This sounds a lot like "The Day of the Dollar".


bigwavedave's picture

one small point. the greek 'money running out by july' did not count the recent non greek law bond payments. so june

Doubleguns's picture

THAT is some distracting avitar!!! Tell it to stop...oh never mind please dont.

Motorhead's picture

No wonder that Singapore is welcoming that Facebook co-founder Saverin with open arms!

Doubleguns's picture

Did singapore follow JPM advice. Poor bastards.

BeetleBailey's picture

Feta Cheese. Gouda.

Feta Greece. Not so gouda.

q99x2's picture

"Only a very bad outcome in Europe would be enough to trigger a US recession."

Had to quit reading at the above line. Got slapped by my conception of reality.

Monedas's picture

The quest for "multiple smegma-events" is what it's all about !        Smegma (natural foreskin lubricant and glans conditioner feta cheese) is an ancient Greek word !     Monedas   1929    Comedy Jihad Summer Cherries Have Arrived    PS:  Long before condoms were invented....Greek women improvised crude diaphragms with grape leaf wads !  How do you wire money in Greece ?  Ans:  Drachma-Grams !

BurningFuld's picture

Good old Flaherty: Maybe Europe should just abandon the Euro. See it's simple!


Mike Cowan's picture

Singapore always has the guns pointed in the wrong direction.

Olympia's picture

How is it possible that the European Union allows the weak states to enter the international money market and borrow the money they need without help – based on their own potentials? How is it possible that the “chain” of interests of euro can let its weak “links” exposed to outside pressuresHow is it possible for a “herd” with common interests to let each “ship” defend itself against the wolves, without help, and its general security threatened? How is it possible for Greece, which represents a minor 3% of the Eurozone’s economy, to be allowed to threaten the other 97% of that economy, due to the latter’s weakness?

The European Union should be the one borrowing from the national banking system – thus dealing with profiteers itself based on its overall potential – not its weak “links” alone. The latter should be under the EU’s protection and constant monitoring. They should borrow from it at a subsequent time and if they became victims of profiteering, the problem should be kept in the bosom of the euro. Domestic profiteering should bring profits to Europe’s influentials, therefore bring profits in the euro area, and not threaten it.

From the Wall Street Crash of 1929 to the Global Financial Crisis of 2007




Authored by Panagiotis Traianou

Lux Fiat's picture

Very interesting charts.

However, the final one, "implications across asset classes", is perhaps optimistic with regards to banks.  If we get another severe banking crisis (some would argue we are still there), I think that despite all of the regulatory and political capture, a Swedish outcome ala the early 1990s becomes much more likely.  Politicians were able to cover for their major campaign contributors before, but when push comes to shove, and voter sentiment has turned against more bank bailouts, they'll be more amenable to letting mgmt, unsecured creditors, and also counterparties, hang out to dry.

SmittyinLA's picture

Fortunately for Singapore they have a large pool of wealthy stateless ex-patriots ready to pick up any fiscal slack that the local population IS NOT willing to fund.



halfacanuck's picture

Interesting info. But you need to stop going on about sigma. You can only get a valid standard devation from a normal distribution, and asset price changes are not normally distributed: they follow a power-law distribution, as Mandelbrot discovered.

Go back over MPT and CAPM and see how they stand up to an honest evaluation once you discard the fallacy that asset price changes are normally distributed. It's all bunk, mate. In the real world, modeled with the correct probability distribution, "high sigma" events are a lot more likely than you think.

halfacanuck's picture

Oh, and let's not forget VaR.

WallowaMountainMan's picture

 "The resulting worsening of financial conditions and softer activity data would likely get the Fed to respond with additional easing, in our view."

sad if they do. fed has the position to sit still and let the world come to the usa. we are solid at the base. give usa a strong dollar, we get cheap oil. etc.

corporations large gainers as they sit on huge cash. all win for usa if fed sit still. once in a lifetime opportunity.


"The Fed knows QE doesn’t do much to help Europe. (For more discussion, see this week’s Fed Watch.) Only a very bad outcome in Europe would be enough to trigger a US recession."

good reason for patience by the fed. patience wins. always (once in a lifetime).


"So far the retrenchment of global European banks from emerging markets has proved less disruptive than feared..."

less than expected is a controllable event.


"but in a financial crisis, overall lending is likely to fall."

cash waits.

"However, it would almost certainly produce an equity market sell off."

thay can read. (patience scores again, as the down is 'gentled'. the rebound would be real and last.)


"Overall, we see about a one-in-three chance of a recession starting sometime in the second half of this year and the first half of next year."

i'm getting, worst case, 2 to 1 to win it all? seems like a no brainer to me. i do agree that "US fiscal dysfunction" is the big ugly in the room. can't imagine the boys at the top don't see this. with all their money they outta be able to make their puppets play nicee-nice.

anyway, loved the article.