Why Greece Needs To Leave The Eurozone But Should Stay In The European Union

|
Includes: FXE, GREK, IEV, NBGGY
by: Lewi Ilkanaev

Summary

The referendum changes the entire game but does not solve the main issue - debt and its repayment.

A Greek default comes closer and repaying debt may only be possible with a stable economic situation and a credible central bank.

Markets are nervous, however risks for contagion are limited.

The recent events in Greece are shaking the financial markets. Almost all indices in Europe came under huge pressure after the Greek Prime Minister, Alexis Tsirpas, called for a referendum in the coming week. The Greek national bank imposed capital controls and ATM withdrawals are limited to 60 euros per day. On Saturday the Greeks withdrew more than 1.3bn euros. The pressure on the economy is enormous and the summer season is coming. Tourism is a major source of income for Greece.

(Greece and capital controls, 29th June 2015)

There are two likely scenarios

First scenario

If Greece would have taken the proposal from its creditors who are mostly the ECB, IMF and the World Bank, then Greece would have received additional funds to make its debt repayments on time. However, money would only be enough for another 5 months, then the whole story would repeat as it did in the last 3 years. It seems that many fear the default of Greece. The main issue is that you do not help a country by giving more loans to repay old loans. If the economy does not work well, unemployment is rising and the governmental deficits are exploding, then something needs to be changed in the way the country is run. Most of the other euro-members are growing, especially Germany is doing well currently. This story could continue and Greece would receive more funds until its debt level is even higher than now. The creditors would however expect that Greece impose higher taxes and cut government spending. But from my point of view economics are not as simple as that. The economy is suffering, the business engine would be killed even more with higher taxes. Only creditors would benefit with this solution, definitely not the Greeks because they would end up paying the debt for the next 20 years without stable economic growth. From my point of view it is more the case that Germany and France fear a Grexit because their banks hold plenty of Greek debt. In case Greece defaults or has a haircut, like it had before, lots of banks and the ECB would lose money. Moreover I suppose the Greeks are fed up with austerity and will not tolerate more taxes and smaller pensions. After all that is the main reason for Syriza's victory. With the first scenario Greece will never be able to come back to normality and will end up paying forever.

(The Greek Dilemma, 29th June 2015)

Second Scenario

This is the second scenario and I personally think it makes much more sense. It is an illusion that Greece will eventually repay all the debt. Its current debt to GDP ratio is at approximately 180% and it is likely to rise even more. Greece needs to be the first country that the EU designs a default for. Otherwise this dilemma will never end. The risks of contagion for other euro-members is not much smaller than it was 2-3 years ago. From my point of view the time is right for a default and a new start for Greece. Eventually the ECB will print new money and buy all the worthless Greek bonds from the German, French, Italian and other creditors. This should not be seen as a disaster but as a chance. The European institutions need to prepare the Grexit well and learn from it and create a mechanism that works in the future if similar situations arise with other EU-member states. If Greece defaults it has two options: it can stay in the euro or it can return to the Drachma. My view on this is that with a cheap Drachma the Greek economy could generate economic growth, exports would climb and the Drachma would create lots of jobs. The decreasing value of the Drachma will only be helpful for the Greek economy.

(The Greek Crisis, 29th June 2015)

As you can see, the Global XFTSE Greece 20 ETF (NYSEARCA:GREK) unveils the tragic situation of the Greek stock market.

GREK Chart

GREK data by YCharts

The National Bank of Greece (NBG)

NBG Chart

NBG data by YCharts

Conclusion

The question remains if the Greek population understands what it is really voting for on the referendum. The current Prime Minister, Alexis Tsirpas, lets the people decide. There is no trust in the local economy right now, and credibility is the most important thing governments need to establish. The EU has failed to deliver that credibility for Greece. I think Greece is better off with its own central bank, otherwise the country will lose another decade.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.