Here we go again for the third time in as many years. Come European summer and, instead of planning holidays in southern Europe, investors are confronted with supposedly irreparable debt problems in Greece.
The bears claim Greece is bankrupt and with the 30% or so interest on its debt and anti-growth austerity being imposed on them, there is not much hope for recovery despite the recent large debt write-off. Gloom and doom outlooks prepare us once again for Greece defaulting on their debt, leaving eurozone followed by economic collapse of Spain, Ireland, Portugal etc.
Then global stocks and European currency fall, peripheral bonds yields shoot up, CDS markets price-in the looming disaster and investors buy German and other safe haven bonds that yield barely above 1% for 10 year holding period. Runs on Greek banks are held back by ECB and Emergency Liquidity Assistance while safe German banks enjoy flood of new deposits from the periphery.
Is the bearish scenario possible? - yes it is, but in my opinion it is not certain and not highly probable.
Disproportionally little attention is given to a possible and probable positive outcome for Greece and Europe at large. Here is the bullish case:
Every new stage of the financial crisis is actually bringing European Union to closer integration which will create conditions for a strong centralized response to the debt problems in the peripheral countries including Greece. The monetary integration is likely to be eventually followed by tighter fiscal integration that will build on the recent fiscal pact.
This will give Brussels powers to issue eurobonds underwritten by all eurozone members and restructure all peripheral sovereign junk bonds. The new finance at reasonable interest rates in single digits will bring much needed relief and set the whole European region on a new path of growth but this time the loans bookkeeping will be run by EU. ECB will support it by lowering interest rates.
There is growing support for the joint-eurobonds in France, Spain, Ireland and Italy. European voters are replacing right wing pro-austerity parties with left-center leadership demanding pro-growth fiscal policies. The tight austerity measures find backers only in Germany but this will change when Germany starts feeling the impacts of slowing Europe on its doorstep and realize that disintegration of eurozone and EU will hurt German prosperity badly.
Germany is the only country that so far has not suffered from the crisis so it does not see the urgency and need for giving up their national fiscal powers to Brussels to rescue what they consider an "irresponsible" south.
They do not seem to appreciate that recent German prosperity was built largely at the expense of the other eurozone countries. Germany was in a stronger starting economic position when the borders opened up for free trade. One currency at lower interest rates than would be possible under German Mark led to much stronger German exports. Free movement of cheap labor from periphery added to German efficiency and competitiveness reinforcing their leading economic position in the EU.
During the recent financial crisis ECB rescued German private banks along with French creditors and Germans have enjoyed inflow of cash that escaped uncertainty of the peripheral banks. German long bond rates are low just above 1% for 10 year bond further helping the German economy while others have to pay up to 30% on their debt.
The recent €1 trillion LTRO liquidity injection not only ensured solvency of the major European private banks for the next three years but also moved bulk of the junk peripheral sovereign debt from private hands to Governments, ECB and IMF. This created environment for the introduction of joint-eurobonds and the debt restructure because it is much easier to shuffle "public" goods.
The joint-eurobonds will most likely eventually happen subject to some safeguards. The question remains how many more "dramas" have to be played out before everybody comes to the table being pressured by the crisis situation that demands quick and bold response. Such radical change would be much harder to accept in "normal" times.
Investors should expect more periods of uncertainty and volatility. Those who believe in a positive solution for Europe should use the bumps on the road to accumulate on the dips to come out at the end with holdings positioned for global growth including Europe.