Greece facing a euro countdown?

Almost six months after forcing through a bond exchange to substantially reduce its debt burden, Greece is still very much dominating political and financial headlines worldwide.

Cutting Greece loose of the euro would certainly spell months of havoc to the markets- Vincent Micallef

Earlier this week, an article in the NY Times suggested that a number of American companies have been preparing for Grexit and the eventual transition back to the (new) drachma. The article cited that BOA Merrill Lynch’s Greek office has sought to send cash over the Greek border in its bid to safeguard client payments to local employees and suppliers, in the event that money is unavailable. JP Morgan Chase has already created accounts in a new currency, while Ford has configured its computer systems to immediately handle a new Greek currency.

This is in stark contrast to what European politicians are leading us to believe. Even major global stock markets seem to think that the euro can be held together with the MSCI World Index, an index comprising 6,000 stocks from developed markets, rallying by just over 11 per cent between early June and end August 2012. Cutting Greece loose of the euro would most likely increase pressure on Italy and Spain and certainly spell months of havoc to the markets.

The American companies are not alone in keeping money away from the Greek banking system – and it is no wonder. Should Germany decide to pull the plug on Greece, and the latter withdraw from the euro, the Greek authorities will freeze all euro deposits in the banking system in preparation for the issuance of a new currency and impose capital controls.

This would be the first problem account holders face – i.e. not accessing funds on demand. The second and more painful issue comes when the euros in the Greek banking system are converted to drachmas (although the methodology to be used would remain to be seen). Upon conversion, there will certainly be a devaluation into the new currency. Devaluation is a cut in a nation’s standard of living – although the country’s exports become more attractive as they cost less, its imports suddenly are inflated by the full force of the devaluation. And for a net importer like Greece, this could be a painful exercise for its residents.

So, if a local had a €50,000 deposit, he has to contemplate withdrawing this money and either transfer it to another bank overseas (hopefully to a non-periphery country!) or simply keep it at home; fearful that Grexit should occur, the holding will be worth much less, say just €30,000 worth of drachmas. The only reason I can think of where perhaps this hasn’t happened across the board is in those instances where deposits are required to meet day-to-day bills.

We need not go that far back to draw comparisons to the Greek euro saga. In 1991, Argentina created a currency board to peg the peso to the US dollar in an attempt to curb hyperinflation and stimulate economic growth. Keeping up the currency board required a fiscal discipline which Argentina could not keep up with – the same could be said of Greece after joining club euro. In 2002, Argentina imposed the corralito, all but freezing bank accounts (withdrawal allowance of up to 250 pesos per week) and forcefully converting US dollars in these accounts into a devalued peso.

Greece’s debt is mainly denominated in euro. Argentina’s too was mainly non-peso. Obligations in a currency other than the home currency after devaluation has the same effect as paying for imports – they become more expensive to service.

Hence devaluation will also have the effect of increasing the debt burden, rendering the recent bond exchange exercise futile and leaving the door open for another credit event involving Greece sovereign bonds.

Perhaps the Greek electorate was well guided in electing New Democracy to govern the country in lieu of Syriza – and the latter’s promise to pull the plug on the euro…

Curmi & Partners Ltd are members of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the author’s objective and independent opinion. It is based on public information and should not be viewed as investment advice in any manner. The value of investments may fall as well as rise and past performance is no guarantee of future performance.

Mr Micallef is an executive director at Curmi and Partners Ltd.