May 22, 2012
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Greece’s future is less certain given the recent elections, as is the outcome of its previous bailout. Is an exit now possible or probable? What would an exit from the euro look like, and how would it be accomplished? Some historical examples give us a clue to the repercussions.
A number of hours per week for me are spent reading through various pieces of sell-side and independent economic and macro research. The merits of such a practice can be debated, but without question it provides a “consensus” of current economic views. Over the last week or two the sell-side has increasingly raised the likelihood of a Greek exit from the euro.
Take for instance JP Morgan, which raised the odds of a Greek exit to 30-50%.
“The fear scenario is as follows…massive capital flight in anticipation of exit force capital controls in Greece, and new IOUs to pay public workers which starts the process to a new currency; capital flight from rest of periphery. If periphery countries then impose capital controls, the monetary union is effectively dead, as one country’s euros are then not the same as another country’s euros.”
We have already seen capital flight within the EU. As Nomura economist Richard Koo stated just recently, “…Spain has a private sector that is deleveraging in spite of near-zero interest rates. But the resulting savings surplus has not remained within the country. Instead it has fled to Germany, causing Spanish yields to rise and forcing the government into austerity.” The average observer can see this in action with bund yields plummeting to ~1.50% as of May 11.
Now back to Greece. John Hempton, a brilliant hedge fund manager with Bronte Capital, touched on this topic in an unnoticed blog post last September. Below is an excerpt, in which he compares Greece’s situation to Argentina’s default in 2001:
When Argentina defaulted not only did the government default but they forced a private default. If you had a debt in US dollars in Argentina prior to the default you were forced to pay it back in pesos. Indeed it was illegal to make payment in US dollars.
Likewise if you had a US dollar asset you got back pesos. A dollar deposit in Citigroup in Buenos Aires became a peso deposit. If you really wanted to keep your dollars you needed to make your Citigroup deposit in New York.
The forced private sector default was necessary for Argentina. The Argentine banks all had lots of US dollar funding. If you devalued without forcing their default then they would all have uncontrolled defaults (a true disaster) and the country would lose its institutions. Telefonica Argentina would have failed too – failing to replay USD debts.
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