“There has been a pick up of deposit flight from Greece,” Charles Dallara, head of the International Institute of Finance (IIF) and chief negotiator in the latest debt restructuring, told reporters in Ireland. He expressed his hopes that the deposit flight could be contained after new elections, “Once you get a new government in place, if that government reaffirms its intention to remain in the eurozone.”
If the ECB with the tacit approval of the EU and the IMF will let Greece leave the eurozone, the costs to both parties will be huge. JPMorgan Chase estimates the cost to the official sector to be at least 400 billion euros ($508 billion), including official loans, exposure of the ECB, and losses of EU banks. This estimate does not include the fallout ranging from a chain reaction in derivatives to contagion spreading to Ireland, Portugal, Italy and Spain, as well as the massive loss of credibility and confidence that EU policy makers and especially the ECB will suffer.
Greece on the other hand would face a complete economic collapse, and without a government in place, the risk of social unrest cannot be underestimated.
Goldman Sachs analysts summed up the economic consequences in a note to clients: “The ’stop' in payments [from the Troika] would precipitate an immediate fall in economic activity, given the need to abruptly close the primary fiscal deficit (worth about 2.3 percent of GDP in 2011).”
“As government arrears (worth about 3.5 percent of GDP) fail to get paid, supplies to public sector companies (e.g., power, water supply) and hospitals would be disrupted and their output and activities curtailed. In this context, the inflexibility of Greek wages will result in higher unemployment, while product market rigidities are likely to imply sticky inflation (or even price increases),” warned Goldman Sachs. The rather academic tone of this analysis masks the human tragedy behind it, already happening now as the country is spiraling into poverty.
U.S. Markets Tumble on Financials
At the time of writing on Thursday, all major markets were deep in the red for the week. The euro lost 1.79 percent since Monday, dropping to $1.27 on Thursday afternoon. European stocks are down 4.9 percent for the week, with European banks underperforming, losing 8.7 percent.
But due to the intricate and interconnected nature of the global financial system, U.S. banks are not off the hook despite the fact that they are better capitalized and have less direct exposure to Greece.
The KBW US Bank Index is down 6 percent for the week, due to the fact that this crisis is not constrained to Europe. As has been seen with the MF Global Bankruptcy, turmoil in Europe can affect U.S. banks, who face counterparty risk in the form of derivative transactions should a large European Bank fail.
Next Steps
Politicians in Greece at this moment are not able to meaningfully contribute anything to solving this problem. As a consequence, the ball is now firmly in the court of the Troika. If they remain tough and cut off funding, Greece will hard-default and exit the euro, despite the fact that it could also default and stay within the euro system.
This, however, is unlikely according to Citigroup chief economist Willem Buiter, “Were Greece to be forced out of the euro area (say by the ECB refusing to continue lending to Greek banks through the regular channels at the euro system and stopping Greece’s access to enhanced credit support (ELA) at the Greek central bank), there would be no reason for Greece not to repudiate completely all sovereign debt held by the private sector and by the ECB.”
If they blink and keep on funding Greece, the loss of face could not be made-up and would be an open invitation to other countries like as Ireland and Portugal to not comply with the rules accompanying monetary aid.
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