Countdown to save the EUR
The EUR is once again on the cusp of another existential crisis – this time it's about whether or not Greece will remain in the Eurozone. If the Eurozone is to survive Greece must be kept on-board.
On Monday there was some optimism that a last minute deal will be struck between Greece and its creditors – in particular over the EUR 1.6 billion repayment to the IMF due at the end of the month. Success should certainly boost the EUR at least for a short while after which the focus will shift to the next payment deadline for Greece.
Failure to make the payment would see the country declared in default and potentially forced to leave the EUR as the European Central Bank would cease supporting its already fragile banking system. Greece would need to revert to the Drachma to print money to pump into its ailing banking system and to provide liquidity to the economy.
A 'Grexit' would leave the rest of the Eurozone looking vulnerable and it would set a dangerous precedent – that it is possible to leave the EUR. It would send a lightning bolt through the other weaker Eurozone members, such as Italy and Portugal.
Speculators would short sell their bonds (drive up cost of government borrowing), sell off stocks in those countries, see money withdrawn from their banking systems and likely hit the EUR as well.
That may not happen with full force immediately. But come the next global crisis, speculators will hit hard. This would create an extremely challenging situation for the ECB, which would have to pull out all the stops to keep the Eurozone together. Eurozone authorities would struggle to convince markets that others will not depart the Eurozone.
EURUSD – waiting for debt decision
Greek debt situation needs closure
Nonetheless, even a deal over the June 30 repayment will not end the crisis. Further repayments are due throughout most this year and beyond and at this stage all are potential crisis trigger points. But Greece's creditors need to thrash out a longer-term deal to avoid a repeat of these dramas and that will mean debt rescheduling and write-offs.
Simply put, Greece is a broken country with a debt to GDP ratio of 175%, 25% unemployment, it's economy has shrunk by 25% and has relatively weak institutions. It needs some breathing space to recover so it can at least come off life support.
And the main reason the Eurozone can't afford to let Greece go is that the EUR itself is still a work in progress. Safeguarding the long-term future of the EUR requires the Eurozone operating more like a single state rather than a club of national states. It will mean centralised authorities acting quickly and decisively to deal with crises as happens in the US, or example, rather than holding endless summits to collectively decide on what to do.
If that level of unity is achieved along with strong governance then it will be easier to allow chronically weak and non-compliant countries to leave without damaging the rest of the Eurozone.
But until then, Greece's debt problems will continue to cast a shadow over the EUR and undermine confidence in the Eurozone.
By Justin Pugsley, Markets Analyst MahiFX