What To Expect When You’re Expecting A Grexit

February 17, 2015 3 Comments

One thing we didn’t expect from this ordeal was the bailout negotiations to be so short. Talks between Greece and eurozone officials was expected to go on well into the night. Instead, the talks ended in just a matter of hours (4 hours to be exact).

EU officials offered Greece a 6 month extension on current bailout plans. Greece refers to the deal as ‘absurd.’ EU officials respond by stating that they are willing to continue with negotiations whenever Greece is ready (ready to be more pragmatic and behave like adults). Now its really unclear whether or not talks will still continue.

So, what exactly is going to happen to Greece? There are no easy answers to this; however, we do know that Greece has a lot of payments to many within the next couple of months.

There are a couple of scenarios. While none of these scenarios might actually be the right thing to do, its all a matter of picking the sin that the Greeks can live with…

Scenario 1: Greece Leaves The Euro

The probability of Greece actually leaving the Euro increased from 20% to 50% among most economist and market analyst. Its difficult to say what level of risk a Greek banking collapse would mean for the rest of Europe. However, we can all assume the worse: Rampant inflation, political uncertainty, massive amount of defaults and an implosion of the european financial sector.

As noted last time, Greek banks lost market access and are losing their deposit ever second of the day. Not to mention, they have very few assets that are eligible for collateral under normal ECB financing program. The only reason Greece is still considered solvent is due to the Emergency Liquidity Assistance (ELA) given by the Bank of Greece. If Greece and EU officials fail to reach an agreement by the end of this month, Greece would official become insolvent and massive banking defaults would occur. ELA funds would effectively be discontinued. 

Scenario 2: An Agreement is Reached Within The Next Few Days

With Grexit probability increasing 50%, does that mean that there is a 50% chance that a deal will be reached? I wouldn’t bet on it. Greece really wants to eliminate the current agreement and create a new agreement that will allow Greece to be more flexible to negotiate a longer term solution. The EU is not budging on that one. They want Greece to honor the terms of the agreement before discussions about easing the debt burden can even begin.

One side is trying to protect european taxpayers, who have already poured more than €200 million euros into the Greek bailouts. The other side has a clear mandate from the people, who have sparked major protest as a result of the resistance from EU officials and the ECB. Not sure whether or not an agreement will actually be reached by Friday. Even if it doesn’t, its still good theater to watch from the sidelines.

Scenario 3: Capital Controls on Greece

A slight lesson from the past. Flashback to the year 2012, and the small island of Cyprus. Like many other economies, the nation took a huge hit in the financial sector during the Greek restructuring mess, with its rising level of debt, credit downgrades and lack luster economy. Discovering that they weren’t immune to the sins of Greece, Cyprus also decided to ask for a bailout package from the ECB.

And after crunching their numbers, it was found that the country needed €17 billion euros to fix their finances and lower debt-to-GDP ratios. To help finance this, the government levied a one-time tax of 6.75% on all deposits under €100,000, while larger accounts were hit with a staggering 9.9% tax. The result, as you can imagine, Cypriots rushed to the nearest ATM they could find and withdrew all of the cash in their accounts. The €400 withdraw limit didn’t manage to stop them either, and several ATMs were emptied out over the weekend. This effectively drained liquidity from the banking system and threatened the island with insolvency.

The Cypriot central bank tried to get around this by lending out newly created money under the ELA protocol. These funds were borrowed from other eurozone central banks, and set up in newly created accounts from fleeing investors. Banks would have effectively gone under without this protocol; however, this was effectively capital flight financed by other eurozone banks. This scheme was too large for anyone to ignore, and essentially the ECB pulled the plug on the whole thing. Eventually the nation of Cyprus had no choice but to impose capital controls, and this is eventually want Greece might do.

Although, the problems in Greece are not nearly as extreme, it is uncertain what would happen if Greece runs out of the liquidity by the end of the month.

So what exactly should you expect when you’re expecting any of the scenarios outlined above? We can look at the Euro for that…

As of right now, February 17th, 2015 at 12:28 pm, the Euro is trading at 1.1388. If Greece leaves the, we can probably see the Euro trading low against the Dollar and break through a key resistance level of 1.1290. It could probably reach August, 2003 low of 1.0559, or it could probably reach the low it reached in March 2003 low at 1.0504. If we expect a deal between the EU and Greece (which I am not expecting), the Euro could test key support levels of 1.2320 and 1.2195. UR/USD was bottoming around 1.1541/46 on January 19th – 21st, before ECB announced QE program on January 22nd. Not really sure what will happen once the capital controls are impose, but I guess I don’t mind taking little ‘wait-and-see’ approach.

But I think I can take an educated guess and assume Greece isn’t going to go anywhere. Syriza is relatively new to this whole ‘governing’  thing, and this is a relatively difficult less to learn. Almost as difficult as realizing that business is not a one-way street, as much as Alexis Tsipras would like it to be. Syriza might have to drop the tough-guy act if they want to be able to play ball with the ECB and other EU officials.

So, within the next couple of days, I can only assume that there is going to be some sort of cooperation between the two parties, when neither of them are planning to budge on their arrangements. With that being said, It’s Drachma Time!

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