Article / 26 June 2015 at 15:30 GMT

Contagion from Greece: don't worry - yet

Blogger / MoreLiver's Daily
  • The markets are not worried about Greece one bit
  • Greece has unified the front against "populism"
  • The casualty will be the monetary union itself

By Juhani Huopainen

In my previous post Worst-case Greece scenario is tolerable, so be bullish I wrote that even a 100-percent Greek default would not be economically or fiscally a critical blow to the euro area. The real risks that Greece could pose to the euro area are political.

Bond yield contagion a non-issue
The sovereign bond yield spreads have risen in recent months as Greece has moved closer to the brink – but the spreads are nowhere close to what we saw at the onset of the euro crisis or in 2012 before the European Central Bank’s president Mario Draghi saved the day and the common currency with his famous “whatever it takes”-speech.

While bond yields have moved higher in countries that could be considered as obvious victims of contagion, large part of the rise came from an overall move higher, and not from increasing country-specific risks.

United they stand - but for how long?
United they stand - but for how long? Photo: iStock
Prerequisites for contagion not in place
Contagion would require one or more of the following:

  1. Decreasing faith in government debt sustainability – possible losses from Greece are small compared to the outstanding debt and would not hurt the ratios.
  2. Self-reinforcing worries of refinancing difficulties – the ECB’s bond purchase programme provides a guaranteed buyer of bonds in the secondary market, making primary issues.
  3. Bank runs in deposit- or interbank markets – bank holdings of Greek debt are small, as most of the Greek debt is in the hands of the official sector. There are no signs of deposit bank runs in other crisis countries.
  4. Economic effects – Greece’s share of Europe’s aggregate demand is small, and its supply is non-critical to the functioning of the rest of the euro area.
  5. Redenomination risk – currently no country in the euro area considers returning to their national currency and forcing devaluation losses to the foreign investors.
  6. Political risks – this is the only thing that Greece could cause, but it will not be what you would think.

Political risk: doing it wrong or unable to do it right
While austerity-weariness, political scandals and general distrust toward national and European institutions has increased in many countries, it has not led to a clear majority for a “populist” party anywhere else but in Greece.

But doing the wrong things – like being supportive of nationalization, exiting the monetary union, running larger budget deficits or defaulting on one’s debt – is not the only way political risk can show itself. We’ve already seen cases where the rise of the populists has led to weak coalition governments that are unable to govern effectively due to their internal disagreements.

United against Greece
As the ECB’s bond purchases have limited contagion to the euro area, the exclusion of Greek bonds has guaranteed that the country does not have market access. At the same time the ECB has through its emergency liquidity assistance (ELA) kept the Greek system afloat during the negotiations, albeit under serious pressure.

The European institutions have - through media and monetary policy - managed to turn Greece into an example to avoid. The mainstream parties in other peripheral countries have been eager to support this institutional view. Funnily enough, countries like Spain, Germany, Portugal and Netherlands have been united against Greece.

This is why the euro area is reluctant to let Greece go and default on its debt and return to drachma. But the euroa area also does not want to forgive the Greece's debts and accept the losses and move on. 

This would end the recent unification of the rest of the Europe and give a bad example to Spain (general election on December 20, 2015) and Portugal (legislative election between September 20 and October 11).

The euro area itself will be the true victim of Greece
The current drama will continue for as long as is necessary, at least until the above elections are over. It plays well for the mainstream political parties in the creditor countries as well, as it hides their original mistake with Greece.

The only political risk that I see from Greece is that those who know better – national politicians who planned and managed the mess that is the euro zone – will not be able to complete a true monetary and economic union. They now know they cannot trust each other because they know they cannot themselves be trusted. Without US-style federalization, the euro is doomed to continue muddling through until it one day won’t.

– Edited by Clemens Bomsdorf

Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform.

Juhani Huopainen Juhani Huopainen
Damn, forgot the table. Here:


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