Decision time with Greece

Dean Peters-Wright

Senior Analyst

                                 

fxKnight.com

                                                               

There is a species of shark that distinguishes itself from the rest known as obligate ram ventilators. The distinguishing feature of these sharks is very interesting. Through evolution, they have lost their ability to pump oxygen through their gills as they have evolved a more efficient way of taking in the oxygenated water through their mouths and flowing through their gills just by moving through the water. However, this means that if they encounter an obstacle, they must head in a different direction to avoid asphyxiation. In short, if they stop swimming, they die.

Have I too much time on my hands? Well sometimes yes; there are only so many documentaries about, well …you can guess. However, the parallel should be obvious as we head out of the worst recession to hit the global markets, into the week that should see a decision being made regarding the austerity measures for Greece; if Greece stops swimming it will share the same fate.

Greece needs money. However, we have all known a ‘friend’ who we have a lot of sympathy for, who has gone through a bad time, made a few wrong decisions and we have said “I feel so sorry for you, I’m here if you ever need to talk”, knowing full well that the one thing he is really hoping for is that you put your hand in your pocket to help him get through the week. Only we won’t, because we are concerned that we’ll never see that money again.

So what do we have here? In order to bail out Greece, that money has to come from somewhere, in this instance the ECB. Governments need money and so interest rates will rise. The reason interest rates will rise is because they will have to borrow money at a higher risk premium because no one will feel as secure in buying government bonds. In order to pay for these higher premiums, governments will have to raise the money by doing what they do best…raising tax revenue. In the face of slow economic growth, the ripple effect will reach out to everyone as wages are rising more slowly and disposable income is dwindling. Without that income being pumped into the economy we find ourselves in a vicious circle which will not be helped by increasing taxes. However, governments cannot print any more money because that would reduce the value of their bonds further and hence not be able to raise money by selling them which leaves them little choice.

So why lend to Greece? Why do we care?

We care because it will affect the very foundations of the EU and if Greece is bailed out, then there is only one place that money is coming from and that is the tax revenue by every member nation.

If Greece is allowed to default then the results could be catastrophic. Not least because the euro would fall in value, strengthening the value of other currencies against it which would have an effect on imports into the euro zone as they would become more unaffordable to buy. This would also then have the knock on effect of stifling growth by exporting nations into the European zone.

In order to secure the necessary funding for a bailout, Greece has to provide the necessary budget deficit and this will only be provided with an increase in tax revenue. To further complicate this, if investors pull their capital out of Greek banks, this could cause a bank run leading to a collapse in credit and hence another credit crunch and as we have seen, credit crunches have an uncanny way of spreading, in this case, to other vulnerable European nations. In short this is everyone’s problem.

We shall see what will be decided, however if there is one sure thing on the table it’s that if the Euro has any hope of securing a credible future on the world stage, it has to survive.

Keeping swimming!

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