Consequences Of The Greek Referendum May Severely Hit Global Markets

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Includes: DIA, ERO, ONEQ, SPY
by: Mateusz Polak

Summary

Greeks vote against austerity, meaning future negotiations with lenders become much less viable.

A Greek default is very possible, and promises of "extending a hand of cooperation" are not to be believed.

The consequences may severely hit the global markets, rather than just the eurozone.

On Sunday, Greeks voted "No" in the referendum to keep up austerity measures in exchange for ongoing bailout loans. Though this was to be expected for several weeks, the Greek voters' decision carries massive consequences for the EU and the world economy. However, at this point, any outcome of the Greek referendum would have been bad for the eurozone.

First off, the mere fact that the voting took place is a sign for other IMF/EBC debtors that it is in fact their choice whether they want to pay off the debt, and what rules they want to accept. The last few years of the relations between Greece and its creditors have been a story of reducing the debt size and interest rate, moving the payments ahead in time, and other concessions by creditors without much reciprocation. It was evidently the case of "too big to fail" all over again.

Secondly, the vote was a follow-up to the actual Greek default on IMF payments, which occurred in early June. The IMF obviously yielded by prolonging the deadline until the end of June, to no avail, and contrary to the creditors' stern words, their patience with Greece seems endless - simply because they know that nothing is to be gained from being harsh with their debtor, and it's better to get even a small amount of money over time than an outright "No" in the form of a default.

Thirdly, the referendum was just the Tsipras government getting a public mandate to do what they have already done - which is to default on the IMF and EBC debt. I would compare this vote to the one in Crimea several months ago, when Russia got the "democratic permission" to take the peninsula "back", because so voted the people. The "No" vote by the Greek voters frees the Tsipras government a bailout card - whatever happens, it was the decision by Greek citizens.

Perhaps most importantly, the Greek referendum clearly demonstrates a failure of the bailout mechanism. What was supposed to get Greece on its feet turned out to end in bankruptcy anyway, while generating massive losses for the creditors. The "too big to fail" paradigm is, yet again, failing. This should remind us that credit is not an all-powerful tool in economics, and we have been using credit as pretty much the only solution since the 2007-2008 crash: first bailouts for banks and mortgages, then zero interest rate policies, quantitative easing, and in Europe, international funding for defaulting countries - with the European Financial Stability Fund as a prime example.

Outlook on future talks

Of course, talks between Greece and its creditors will continue. The referendum does not mean the end of cooperation, an automatic default or Grexit. However, any pressure from the creditors to enforce austerity measures on Greece will fall on deaf ears. This, in turn, means that Greece will not be able to service its debt - it was unable to do so even with the austerity measures in place. That said, promises (of eventual repayment) will be given, even if they are completely unrealistic; Greek Finance Minister Varoufakis already commented that they will "extend a hand of cooperation" to the EBC and the IMF, but talk is cheap. The creditors, on the other hand, also have their hands tied, although this may not be so obvious. If the IMF or EBC ease their payment demands too much, the other indebted countries may feel "cheated" and demand similar treatment. If Greece is allowed to pay less of its debt and get other benefits, why should Ireland or Portugal not get the same treatment? In short, EBC and IMF will have to at least pretend to be stern against Greece, but again, talk is cheap, as Greece will downright refuse any reforms due to the vote result. Hence, there is very little room for negotiation left, and promises made by either side should not affect our decisions, as it is very unlikely that they will actually lead to anything.

Grexit looms

The "No" in the referendum does not mean an automatic Grexit. While many ask whether Greece will be forced to leave the eurozone, the real question is - Should they leave it of their own accord? A return to the drachma would actually be beneficial for Greece - they are a popular tourist destination and an exporter of petroleum goods. A weak currency (and the new drachma would definitely be weak, if worth anything) would actually provide Greece with massive revenue from tourism and export, making it relatively easy to service the current national debt and tie up the budget nicely. Import goods would obviously be ridiculously expensive, but this is a much smaller problem. Tourism will also generate some natural demand for the new Greek currency, keeping it off the rock-bottom. As the dust settles, the Greeks would return to normalcy. In fact, a Grexit may bear much more serious consequences for the eurozone than for Greece. The euro makes sense as a currency only if it is stable and reliable. If one day the euro represents the economies of 19 countries, and another day only 18, it is not reliable at all. The eurozone becomes a liquid conglomerate one can enter and exit at will. That is why the other EU states may work toward Greece staying in the eurozone, rather than pushing it out, even if they pretend to do the opposite in a vain attempt to force Greece to repay the debt.

Consequences for the global markets

I wrote about the possible consequences for the EUR/USD , ^DAX and ^ATH here. However, Greece's default may be a black swan worldwide. Global markets are happily scraping historical records after seven years of boom. How fears over the Greek default have moved the indices down in the last weeks (70 points loss for the S&P 500) only demonstrates that the situation is not included in the prices yet. The Greek problem is systemic, as it shows us the inefficiency of the lending system we have put so much faith into. It shows that no matter how much help you give to a failing economy, it may still fail. What was considered the "new economic reality" may not be as effective as expected. It is very similar to the information we received prior to the 2008 crisis - then it was too many unserviceable mortgages, now it is an unserviceable country. To cite the Financial Crisis Inquiry Commission, the 2008 crisis was caused by "dramatic failures of risk management at many systemically important financial institutions, [and] excessive borrowing". Unless we pretend that the eurozone did not need the billions of euros it gave to Greece, it seems exactly like a failure of risk management and excessive borrowing. While I don't expect a downright crash just now (unless we find out something we did not know yet about the financial stability of other countries, the IMF or the EBC), this should definitely be a reality check for markets to price in the turbulence we are entering. The Wall Street indices, ^SPX (NYSEARCA:SPY), ^DJI (NYSEARCA:DIA) and ^NDX (NASDAQ:ONEQ) included, are not safe from it either. The minimum I would expect is a healthy correctional move toward the 1980-1960 range on the S&P 500, and very possibly further down (toward 1870-1860) in the following weeks. For the Nasdaq, the respective levels would be 4040-4080 and then 3700-3750, and for the DJIA, 16950 and then 16000. The EUR/USD (NYSEARCA:ERO) may well see the 1.04-1.05 range again, perhaps later pushed toward parity. These estimates, however, are based on technicals, and technicals are of little importance following events as crucial as this one.

Disclosure: I am/we are short ^SPX, EUR/USD.

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.