Greece seems to be stuck between political forces on the left (the Syriza party) and fiscal forces on the right (debt burdens, European Monetary Union austerity controls). Is there a viable way out? What are the options? Brooks Ritchey, senior managing director at K2 Advisors®, Franklin Templeton Solutions®, harkens back to a popular 1970s tune as he explores these and other questions.
J. Brooks Ritchey
Senior Managing Director at K2 Advisors®, Franklin Templeton Solutions®
Periodically, when commuting home in the evenings, I enjoy listening to a bit of music. The songs that resonate with me most are those typically associated with meaningful memories or events from days gone by—sappy ‘70?’s glamour band ballads for example, invoking awkward recollections of grade-school dances. On a recent drive I was accompanied by the classic tune from Stealers Wheel, “Stuck in the Middle With You,” which brought to mind the current situation in Greece.
The Greek Odyssey: How We Got Here
To understand where we are with Greece and what can potentially happen, I think, as investors, we need to understand some history. I’ll summarize the situation for context—at least as it pertains to finance.
Roughly four years ago, Greece fell into crisis. Its debt-to-gross domestic product (GDP) ratio was around 170%,1 and interest rates on Greek 10-year bonds spiked above 40% in 2012 as investors worried about default. It was clear at the time that Greece could not pay its debt. After much hand wringing and last-minute negotiations, the Greek government, the European Commission and the European Central Bank (ECB) collectively agreed to a support package. Back in 2012, we pondered whether the Greek story as it pertained to the euro had “jumped the shark.”
In American pop culture, the phrase “jump the shark” signifies the exact time a television program, band, actor, politician or other public figure (we would add eurozone member country to this list as well) has taken a turn for the worse, gone downhill or become irreversibly bad. The expression derives from an episode of the 1970s American television sitcom Happy Days, where a water-skiing Fonzie (Henry Winkler), wearing swim trunks and his trademark leather jacket, jumps over a confined shark, answering a challenge to demonstrate his bravery. For a show that in its early seasons depicted universally relatable experiences against a backdrop of 1950s nostalgia, this marked an almost cartoonish turn toward attention-seeking gimmickry. Critics of the show suggested that the shark-jump episode marked the beginning of the end as the show became a caricature of itself before its ultimate demise in 1984.
So, back to 2012, when the panic surrounding Greece was diffused temporarily with a European Union (EU) bailout package, everyone seemed to breathe a sigh of relief, and interest rates on Greek debt fell to levels even lower than before the crisis a few years prior. Of note, the EU’s decision to bail out Greece was not an entirely altruistic move, as the vast majority of what was owed was to French, German, Italian and other core banks. So a support to Greece was at the time really a support to the entirety of Europe.
Fast forward to today: While some role players have changed (enter the Syriza party), circumstances have generally not with regard to the Greek debt burden. For the most part, Greece and the EU seem to be right back where they started, except this time the core European banks appear to be better insulated.
We have arrived at this circular juncture because the “solution” established in 2012 did little in terms of long-term sustainability, in fact—quite the contrary. We view Greece as having been pushed further into depression, and years later, unemployment still stood above 25% (more than 50% among its youth).2 Currently, Greek debt-to-GDP is above 170%,3 and the country is again faced with the prospect of not being able to meet its debt obligations.
In January of 2015, the Greek electorate, frustrated with years of imposed austerity and not seeing much in the way of progress economically, decided it wanted change. They voted the left-leaning Syriza party into office on the back of campaign promises to reverse many of the EU-mandated austerity measures that were implemented as part of the 2012 bailout agreement.
The Syriza view is that the austerity Berlin and the rest of Europe demanded in 2012 was unreasonable, making it more difficult in the long run for the county to address its debt burden. Greece’s new finance minister, Yanis Varoufakis, publicly raised the issue of renegotiating Greece’s $365 billion in debt, and is pushing for relief in the way of longer maturities, lower interest rates and repayments linked to the country’s economic growth.
In response, Germany has made it very clear that restructuring of the debt is not an option, and other eurozone members have generally presented a united front in this regard. In addition, stringent austerity measures would still be attached to any Greek bailout package in the future. For Syriza, however, this doesn’t seem an option.
So, politically, it seems we have reached an impasse; on one side we find German Finance Minister Wolfgang Schauble, and on the other we have the Greek electorate and the Syriza party. Stuck in the middle are Greek Prime Minister Alexis Tsipras and his compatriot Finance Minister Yanis Varoufakis, faced with the seemingly insurmountable dilemma of trying to give the Greek people their cake while allowing the rest of Europe to eat it as well.
That is to say they are faced with trying to serve two masters. Opinion polls show that many Greek voters support Athens’s tough negotiation tactics. But the polls also show that most Greeks want their country to remain in the eurozone—but to do so would require agreeing with the zone’s austerity demands. I think this would be the technical definition of a pickle.
“Grexit” Scenarios: The Potential Impact on Greece
Some members of Syriza believe that the best option for Greece to regain its financial independence would be to default on its debts and cut loose from the euro. I am not sure this would be the best approach, but let us consider the potential impact of such an action.
As Syriza imagines, on the surface this may seem like an attractive option. Presumably by doing so, Greece’s debt would be cut to more manageable levels, and bringing back the drachma would allow the country to devalue its currency and strengthen its competitiveness. One might say this is the utopian vision. The potential reality of bringing back the drachma (the legacy Greek currency), in my view anyway, looks a bit more nightmarish.
if Greece were to suddenly leave the euro the implication (at least as we see it) is that Greece’s banking system/economy would be, for all intents and purposes, bankrupt. As such, Greece’s currency would presumably be about worthless in the near term, and likely be the last place outside investors would be willing to park their capital; hence a sharp decline in value against the euro. Our worst-case vision: Banks could totter, cash machines would likely be emptied, interest rates would probably spike, and companies would go bankrupt, including, perhaps even the country’s largest electric utility. Would businesses have