The Reckoning

Peripheral Damage Goes Global, Part II

A Greek exit from the eurozone would see the unstable return of the drachma, shown here atop euro bills

Photo Illustration by Milos Bicanski/Getty Images

Nothing Greek voters do Sunday can solve Europe’s debt crisis—the leaders of Europe’s larger economies have made sure of that with denial and half-measures now entering their third year. But Sunday’s Greek elections will tell us, probably within a few days of the result, whether the European debt crisis will drag on interminably, or if something more precipitous is about to happen.

Right now, voters who recently appeared to have reached the limits of their tolerance for IMF/EU imposed austerity (and loss of Greek sovereignty) seem to be having second thoughts. In May, a round of voting produced a hung parliament and gave a majority to the upstart Syriza party bent on resisting further benefit cuts, labor reforms and other change demanded in return for bailout funds. The old guard—the Socialists and the relatively more conservative New Democracy parties—were rebuked.

Now, however, polls ahead of Sunday’s vote show the New Democracy party running even with Syriza, suggesting that Greeks may be rethinking the appeal of defying Europe and taking their chances with an outright default and reintroduction of the drachma. New Democracy could notionally form a government with the mainstream Socialists and conceded just enough to Brussels to continue muddling along as the eurozone’s weakling.

But the Greek government also banned polls this week in an effort to prevent panic, meaning news reports on the likely outcome are even less reliable than usual as rival parties leak “internal” numbers to the media. So, the circus rolls on.

Polls or no polls, the world is girding for the results. So, as promised, let’s look at the fallout expected if Greece does, as some think it will, put Syriza in office, stiff Brussels, default on its debts and/or ultimately exit the single currency—the so-called “Grexit” scenario.


At the Eurozone’s (EZ’s) largest banks—many of whom lent as recklessly as the Greeks borrowed during the bubble years—analysts have been running the numbers on how badly exposed they might be to an outright run on Greek banks if the defiant Syriza party takes power. Central bankers fearful a crisis will make their national debts unsustainable, too, are preparing pleas for help—from the European Central Bank (ECB), IMF, and global investors.

Publicly, of course, most are downplaying what is looming this weekend. But in Germany, HypoVereinsbank’s chief executive Theodor Weimer conceded what his peers refuse to discuss: “The management board decided today that we will meet on Sunday if the worst case occurs,” he told reporters Wednesday.

The “worst case” is something other banks have not spoken about, though plenty has been written about the impact inside Europe. German and French banks, in particular, have exposure of about $90 billion, and should a Greek default/bank run occur the write-downs could be significant. (U.S. private bank exposure is estimated at about $7 billion. That’s a lot of cash, but not an existential issue, and as in all these instances, the risk is probably of a write-down, not an outright default.)

But the real question is contagion. These banks will survive Greece whatever happens because the ECB and their own governments will come to the rescue. The ECB may even prevent “transmission” of the crisis through various capital injections or other emergency measures.

But there will be no easy mechanism to halt contagion on the psychological level. The image of Greeks pulling their funds from their banks in panic could touch off similar runs in other weakened states—Spain, Ireland, Italy and Portugal. Indeed, even against giant French and German banks could face the equivalent of runs—credit downgrades, a lack of counterparties—if the worst case hinted at by the HypoVereinsbank chief does come to pass. This is a climactic moment for the euro.


Again, keeping the catastrophic notion of a Spanish exit from the euro—a “Spexit”—off the table for the moment, even a far smaller “Grexit” has implications across the planet.

Growth across the eurozone (EZ) would likely halt completely—with the countries remaining eurozone in recession and contracting by about 2 to 3 percent in 2013. That will hit some neighbors and trading partners hard.

Depending on who you believe, for instance, the British economy—already in recession – will plunge again by 1 to 2 percent further in GDP terms during 2013 if the Grexit occurs. This is less about exposure to Greece, which is moderate, than the loss of business on the continent as the Eurozone’s huge import-hungry economy drags the world down with it.

For all intents and purposes, this means Britain has not grown in real terms since before 2008 and has grim prospects in the near future, especially if the current government cleaves to its own austerity policy. At the moment, its decline is general rather than relative.

Russia will suffer even more dramatically, in part from the loss of markets in the EU, but mostly because oil prices should fall—perhaps as low as $80 per barrel in some scenarios, far below the $110 pb that Russia needs to make money on oil. Optimists think this means Russian growth that was humming along at a 4.9 percent pace in the first quarter of this year would go to 1 percent or perhaps flat line. For a patronage and subsidy heavy country like Russia, that is a disaster and it could lead to political problems for President Vladimir Putin if it persists. I see 1 percent in Russia as very optimistic.

Analysts of Turkey see a mixed picture. As a heavy importer of euro denominated goods, as well as oil, Turkey could benefit from a euro devaluation (which, effectively, is looming). Turkey’s economy has slowed since its double digit 2010 growth, but its real challenge had been inflation and a rising budget deficit. A euro trading possibly at parity with the dollar would help both, and so will lower oil prices. On the other hand, Turkish remittances from émigré workers in Europe are significant, and they would be hit hard by a Grexit. But on balance, the effects are not so bad in Turkey.


A Made-in-Europe Grexit disaster would have three major effects that ripple far from the crisis Mediterranean ground zero:

·         a new shock to the financial system as EZ banks teeter and withdraw from traditional markets;

·         a loss of markets for countries that trade heavily with Europe;

·         and a drop in the price of oil.

Of these, the financial shock is the most difficult to gauge. While it is true that banks in Asia and the US are not overly exposed to the central crisis (bad loans to Greece), any large bank is inevitably entangled in complex deals with its peers in Europe. As much as regulatory reform has aimed to prevent the repeat of 2008, when Lehman’s collapse led to consequences none of the world’s banks (or their sleeping regulators) seemed to have anticipated, the continuing secrecy that shrouds derivatives markets makes it impossible to tell what the collapse of, say, Spanish giant Santander or France’s Credit Agricole would really have.

Suffice it to say for now there would be another round of retrenching in the banking industry, which will be shunned by investors and beset by new calls for tough regulations. That may cause them to stop making some kinds of loans—whether to “frontier markets” in Africa or certain Latin American countries or to average people who want to buy houses, cars, start or expand small businesses, or finance college educations in the developed world. It’s not 2008 all over again, but to some people it may seem very hard to sense the difference.

The loss of Europe’s import appetite will hurt its major trading partners. Besides Russia, Britain and the countries of central and eastern Europe, this will hurt North Africa and some sub-Saharan African countries, including large ones like Kenya (agriculture and textiles) and Nigeria (agricultural and energy exports), and South Africa (agriculture and mining).

Cheaper oil will have more predictable effects. Iran needs oil be at about $88-to-$90 a barrel to break even and fund its government without borrowing, and that could mean real trouble when sanctions and other pressures are added up. Iran’s reaction might be conciliatory, but that would break a pattern. More likely, it might ramp up the rhetoric and try to put some political risk back into the thinking of oil traders in the hope of keeping oil from plunging toward $80.

Other Middle Eastern producers can generally weather much lower prices, but they increasingly have been using proceeds to keep social peace. (Iraq, with a $100 requirement, is a major exception). Such “social spending” in places like Saudi Arabia, Bahrain and the UAE get harder the lower the price of oil. The Arab Spring may still have some spring in its step yet.

For oil-hungry East Asia, mired in stagnation, lower oil prices is a gift unlikely to be squandered. Japan will buy all the oil it can as prices below $90 and stockpile it. China, South Korea and India, too, may be tempted to use this as a “hedge” moment and create their own equivalent of the Strategic Petroleum Reserve.


Perhaps even more seriously, China will feel a very serious pinch. For all the talk of U.S.-China codependency, China actually exports more to the European Union than to the United States. Already feeling a slowdown from its breakneck growth of recent years, China has started pulling investments from Europe in a symbolic protest at the incompetence of policy responses to the crisis.

Uncertainty and lower demand inevitably show up in China regardless, and this will mean a less pliable Beijing when it comes to the RMB’s exchange rate and a redoubled drive to undercut other manufacturers as the dwindling number of growing, healthy export markets get more competitive.

Politically, it means an ever thinner skin among China’s elites, consumed as they are by the unspoken deal with the elite: ‘we in the communist party engineer growth, and you urban elites get rich and shut up.’ That deal can’t last if Chinese growth falls, as it may this year, to the neighborhood of 7 percent. (Most experts, including many in China, believe China needs to grow at 9 percent in order to maintain social stability).

Tomorrow, Part III: The Fallout in America