Aaron Schaefer

Jun 30 2015

Greece: Containment More Likely Than Contagion


  • The Greek government threw a wrench into official negotiations by calling a referendum on bailout conditions.
  • As a result, the likelihood of Greece having to leave the Eurozone has increased, boosting market volatility.
  • Whatever the outcome, it is likely to be messy, but economic and market effects should be fairly well contained.

Greek Prime Minister Alexis Tsipras shocked observers on Saturday when he announced a July 5 referendum on the bailout conditions offered to Greece by the troika (which includes the Eurozone, the European Central Bank [ECB] and the International Monetary Fund). A day later, Tsipras said that Greek banks would be closed in the interim (in order to protect the banking system’s deposits) and capital controls imposed (in order to limit financial flows out of the country). These actions have intensified concerns about a Greek exit from the euro system, and investors are once again grappling with the potential impacts on financial markets and the European and world economies. While some analysts are concerned about the repercussions, including the possibility of financial contagion, we believe the damage outside of Greece is likely to be contained.

First, it’s important to consider how the referendum will be framed. It sounds as though it will be an up-or-down vote on the final bailout conditions, rather than a vote on whether to remain in the common-currency area. If true, a “no” vote wouldn’t necessarily mean that Greece’s departure (or expulsion) is imminent. The referendum’s most immediate impact will probably be on whether Tsipras’ left-leaning Syriza party remains in power—and, subsequently, on who will represent Greece once negotiations resume (whenever and however that happens). Confusing matters further, the bailout offer is set to expire on June 30, almost a week before the referendum takes place.

Second, while we won’t be surprised to see more bouts of volatility, we believe any damage caused by a Greek exit should be fairly well contained. There are several factors supporting this view:

  • Since the 2008-to-2009 global financial crisis, cash in circulation within Greece has increased from 25% of gross domestic product to over 60%, according to the Bank of Greece. With an increasingly cash-driven economy, the closure of the Greek banking system should be tolerable for a short time (although the long-suffering Greek economy will certainly be hurt even more by these actions).
  • In recent years, cross-border lending to Greece has declined by well over 90%. And almost all of the country’s debt is now held by official institutions that are capable of and willing to absorb portfolio losses.
  • In recent years, the ECB has finally assumed a traditional and critical role of central banks—to function as a lender of last resort during financial and economic crises. Thus it should be able to respond effectively (and with a variety of tools) to any threats that arise from further events in Greece.

So far, markets seem to agree with our view that, outside of Greece, any damage is likely to be contained. Despite initial jumps in equity-, fixed income-, and currency-market volatility, sentiment has not fallen off a cliff. For example:

  • Yields and yield spreads on the debt of Eurozone-periphery governments have risen in response to the weekend’s events (yields move inversely to prices). But yields are still below levels last seen a year ago. And for the two largest economies of the periphery (Italy and Spain), they remain comparable to those of U.S. Treasuries.
  • The euro initially fell when Asian trading opened on June 29, slipping below 1.10 U.S. dollars. However, it rebounded to above 1.11 as of this writing and remains above the lows seen in March and April this year.

The Greek debt saga seems never ending. Indeed, in our view, it will likely continue until there is substantial debt forgiveness in exchange for the economic reforms demanded by the troika. However it may play out, we believe the overall impact should be reasonably well contained. Greece is not a large contributor to global economic growth; and for several years, Europe’s financial system has been implementing policies and repositioning in ways that should limit the potential contagion from a Greek exit—however messy it might be.

Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company.

Investment products are not a deposit, not FDIC insured, not insured by any federal government agency, carry no bank guarantee, and may go down in value.
Aaron Schaefer

About Aaron Schaefer

Aaron Schaefer is Vice President, Trust Investment Officer at Hills Bank’s North Liberty location on Forevergreen Road. He has been at Hills Bank since 2004 and manages the investment area of the Trust and Wealth Management division. Aaron can be reached at aaron_schaefer@hillsbank.com.

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