‘Crazy Man’ Greek Debt Strategy Hurt EU Viability

The economic crisis in Greece is playing out with political and economic ramifications that are causing, and will continue to cause, damage across Europe.

As Breitbart News reported a month ago in “Greek Left Over-Played their Hand–Now Desperate for EU Debt Deal,” the EU’s most socialist state and its lenders can now only hope for is a temporary agreement to prevent a chaotic Greek default and quick exit from the euro currency union. A “Grexit” would harm global financial markets in the short-term, but the drawn out negotiations have already eroded confidence in the viability of the European Union.

According to Stratfor Global Intelligence, Athens and its lenders still have a chance to negotiate a deal that could prevent a Greek default. For an catastrophic default and rapid exit from the eurozone to occur, Greece would have to fail to reach an agreement with its lenders and not pay the International Monetary Fund by the June 30 deadline.

The International Monetary Fund (IMF) was set up as the ultimate “lender of last resort” to developing countries that had borrowed money internationally, then ran into repayment difficulties, then lost access cash as capital markets dry-up. When that happens, the IMF usually ponies up a giant loan and the country is saved from the consequences of its own irresponsible borrowing. Under this scenario, not only does the developing country get bailed out, but its private creditors also get bailed out. Taxpayers in developed nations, which are the IMF’s main shareholders, end up footing the bill.

Economists refer to this activity as creating “moral hazard.” Developing nations are willing to take more risk borrowing money, and their lenders are willing to take more risks giving larger loans, because they know the IMF will eventually bail them both out.

But interestingly, no IMF loan has actually ever defaulted. Greece may be the first. At that point, 1) Greek banks would stop receiving liquidity from the European Central Bank; 2) Greek savers would panic and try to pull all cash out of banks; 3) Athens would close its banks for a couple of days; and 5) Greece would print some kind of currency.

Greece would then either be suspended from membership in the eurozone or expelled completely. But regardless of the specific legal mechanism and language used, there would be a Greek exit from the currency union before the end of the year.

But a traumatic Greek exit from the eurozone would probably cause depositors to withdraw their savings from other potentially vulnerable eurozone members such as Portugal, Spain and Italy to avoid suffering a similar default. Investors would also divert into the sovereign bonds of more solvent states such as Germany, the Netherlands and Austria, making it more difficult for countries in Europe’s weaker states to find financing.

The European Central Bank’s promise to protect the eurozone calmed financial markets for the last 3 years. However, a disorderly Grexit would probably cause a panic in the weaker EU states as access to borrowing shriveled. It would also cause political turmoil in the stronger states, as Eurosceptic taxpayers realized they may be are on the hook for all the bad loans made to weaker EU states.

Regardless of the outcome of the Grexit, financially vulnerable countries will see Germany as the villain.

Greece’s socialist leaders know if they leave the EU, their new currency will be tremendously devalued and many of its people will be impoverished. But wildly cheaper wages will cause jobs and investible euros to flow into Greece. As the Greek economy takes off, Eurosceptic parties would become ascendant across the EU and threaten to blow up the currency union.

Bond yields started rising between late February and early March in both the weaker and stronger states in the EU. Greece has been playing the “crazy man” strategy of sounding like they are willing to have a chaotic default. The constant threat of a Greek default and exit from the union has proved just as dangerous as an actual Grexit.

Although Spain and Italy are the most financially vulnerable states to a Grexit, France’s political situation potentially poses the greatest threat to European Union survival. The nationalist National Front party is very popular and is positioned to be the strongest single party in the 2017 Presidential elections.

The Greek crisis vindicates their anti-EU rhetoric, while the United Kingdom’s push for a referendum on its membership in the European Union has inspired the French party to promise to offer the same referendum. Stratfor believes the European Union could survive a Greek exit, but it would not survive France leaving the bloc.

Despite what Greece does by June 30, the damage to the currency union will get worse if they go or if they stay.