Fears are rising everywhere that Greece will make a disorderly exit from the euro. The odds of this happening are extremely low even if the opposition party Syriza and its charismatic leader Alexis Tsipras emerge victorious in the upcoming June 17 elections. Tsipras has called for a renegotiated bailout package that eases the burdens of austerity and favors growth. But he has said he thinks it is best for Greece to remain in the euro.
Chancellor Merkel of Germany and the head of the IMF Christine Lagarde have said Greece must honor the bailout package and there will be no renegotiation. They are bluffing. We all remember U.S. Treasury Secretary Paulson informing both Lehman Bros and AIG that they would not receive a bailout. Lehman instantly went into bankruptcy, collapsing global financial markets and within less than 24 hours Paulson bailed-out AIG. Merkel has gone so far as to suggest Greece should hold a referendum on whether or not to remain in the euro. This will not happen for several reasons.
First and foremost there are no legal mechanisms built into the Maastricht Treaty to kick a member out of the euro. So the decision on whether or not Greece stays in the euro is up to Greece, not Germany. While there is significant support in Greece to renegotiate the bailout terms, there is not significant support to leave the euro. If Greece were to leave the euro they would have to default on the government debt or risk hyper-inflation. The only way for the Greek government to pay back the euros they owe would be to print money. And since they would owe a currency they don't control market speculators would continuously hammer their currency into the ground.
There are very few Greek businesses prepared to return to the drachma. Their debts and contracts are in euros and those with large amounts of leverage would face bankruptcy. Individuals in Greece are in the same boat as the businesses. Few are prepared to leave and their debts are also in euros. If Greece leaves the euro they must default. A return to the drachma will not prevent a default and the consequences of being unable to access credit markets in the future.
However, Greece could choose a strategic default and remain in the euro. This is precisely the strategy Tsipras is threatening if he wins the elections and Merkel and Lagarde refuse to renegotiate in favor of more immediate growth for Greece. How long could Greece hold out with no bailout money? Probably for many, many years if they stop paying the interest on their debts. State budget expenditures for the first four months of 2012 equaled 25,291 million euros. According to the preliminary data available from Greece for the execution of the State budget for the four months January - April 2012, on a modified cash basis, the State budget deficit amounted to 9,098 million euros.
During the same period, the State budget primary deficit amounted to 1,679 million euros. The primary deficit is the deficit without factoring in interest payments. This means the Greek government would need to increase revenues or cut spending by a combination of less than 7% of their government's budget, not their GDP. Basically, Greece would only be 5 billion euros short of running on a cash basis for all of 2012 with no changes. In a strategic default Greece could stop capital expenditures for a short period of time which would cover 2/3 of the gap.
Greece could also get short term loans by pledging hard assets such as the marinas and casinos the Greek government owns. In fact, last year the IMF estimated the asset portfolio owned by the Greek government was valued at 280 billion euros. Greece is positioned to pull off a short-term strategic default or a long-term default. Germany and the IMF can take their pick. If Tsipras wins he actually holds the cards, not Merkel and Lagarde.
If Greece defaults it triggers the credit default swaps backing Greek debt. It also means that non-Greek banks that hold Greek debt would have to take substantial write-downs on that debt. The financial markets would start to freeze up as varying financial institutions would be hesitant to do business with institutions they suspected were vulnerable. The private markets would also instantly spike interest rates to economically weak European countries like Portugal, Spain, etc. The dominoes could crash into each other forcing a massive bailout or economic collapse on a scale many times larger than the problem with letting Greece have a better deal.
The only way out of such a crisis would be massive printing of the euro by the ECB, the very thing Merkel wants to avoid at all costs. There is no doubt Merkel and Lagarde will blink. If Tsipras loses the election there will probably be a "sweetener" offered to Greece right after they wink, wink "reaffirm" the terms of the bailout. The odds of Greece leaving the euro are extremely low. But while not as low, the odds of Greece having to actually go through with a strategic default if Tsipras wins the election are also low. The latest election polls in Greece are within the margin of error and the outcome of the vote is a coin toss at this point.
If Greece doesn't leave the euro or go through with a strategic default then that would take a lot of pressure off of the financial markets and particularly the financial industry. Big banks like Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), Citigroup, (NYSE:C), Bank of America (NYSE:BAC), and J.P. Morgan/Chase (NYSE:JPM) will be the major beneficiaries of acceptance of the original package or a renegotiated bailout package.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.