According to Reuters, “Greece and its creditors were continuing talks on a cash-for-reforms deal, but are expected to miss a self-imposed Sunday deadline for reaching an agreement to unlock aid.” Here we go again ...
It has become clear in the last weeks that Greece does not have the money to pay back its creditors, first and foremost the IMF. It's even worse, as minister of Finance Mr. Varoufakis keeps on stressing that his country is simply not capable of ever paying back the accumulated debts.
Recent figures have pointed out that Greece's government expenditures have decreased with 6.2% year-on-year! That is highly unusual for a country which is governed by a far left-winged government. It only confirms that Athens is desperately hoping for a solution. Time is up, by all means. Because of that, few options are left.
We see three options for Greece, going forward.
1. Additional emergency funds
The first option is that the Troika unleashes the pressure. If that were to happen, Greece could get access to additional emergency funds. However, it is not likely that Europe, the ECB and the IMF will relax their requirements vis-à-vis Greece. The opposite is likely to happen: new funds will come with new requirements. It is a matter of giving and taking.
Greece is really not able to adopt additional measures. It is even not capable to respect the current agreements.
This first option seems not interesting, nor feasible. It is a form of kicking the can down the road, without solving any problem. There is plenty of proof for that as evidenced by developments over the last couple of years.
The truth is that the Greek economy is still falling off a cliff, even with all the savings and other measures taken since the crisis hit the country.
Another option is a Grexit in which Greece would leave the Eurozone. That would allow the Greeks to introduce the drachma and manage their own monetary policy. If that were to happen, the country would immediately strongly devalue its newly introduced currency. As a result, a devastating hyperinflation would hit the country. The Greeks would suffer even more than today, but it would likely be a short pain, followed by a gain.
History has shown that a strong devaluation often results in an economic boom. In the case of Greece, its products and services would become very cheap for foreigners. Especially tourism, export products and other segments of the Greek market should benefit from a boost in demand.
The drawback of a Grexit is that the international relationships will be severely compromised. Cutting of the ties with Europe is not really desired by the Greek population. In addition, the country would be more vulnerable to pressure from the Middle East, Turkey or Russia.
In sum, this option is far from ideal.
3. Northern euro and southern euro
A third and last option is some sort of consensus. Greece would stay in the European Union, but would have its own currency which it can be devalued if required.
This concept has been discussed in the past, and would split the monetary union in two areas. Practically, it would probably mean there would be a “northern euro” and a “southern euro”. That idea was prone to a lot of criticism, but is getting increasingly more proponents.
Surprisingly, it was German finance minister Schäuble who had put this option forth, according to sources close to the minister. He referred to Macedonia, a small country north of Greece, that is using the euro but is not part of the European Union. Mr. Schäuble concluded that the opposite would be possible as well.
This type of consensus solution is being increasingly accepted, given Greece's extreme financial situation. In such a case, it would not be of primary importance whether Greece would still be part of the European Union.
The third option discussed above would not be a bad deal for Greece. It was less than a decade ago that Iceland was experiencing a similar situation: no money and too much debt.
A strong devaluation of the Icelandic krona made the financial crisis at that time even worse. But Iceland recovered quickly, and a couple of years later it had the highest growth figures in Europe.
A Perfect Storm
A Greek devaluation process would put the future of the euro at risk. It is not only Greece which is waiting to be rescued, as there are more European countries who would be happy to adopt a similar “solution.”
These events will put additional pressure on the euro compared to its competitors (i.e., the U.S. dollar, yen, yuan, and the likes). European leaders are really between a proverbial rock and hard place. It is worth noting that financial markets are hardly impressed by the upcoming changes in Greece particularly, and European Union in general.
This has the potential to cause a perfect storm in the markets. Fears around Greece have a tradition to send gold prices higher. We expect investors to choose for gold when the Greek situation escalates.
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