The Greek drama intensified last week causing markets to move erratically. The on-again, off-again deal between Greece and its creditors is fraying on investors’ nerves as the ending is becoming way too close to call. Early week gains on news that an agreement was nearing were quickly eroded, as the news broke on Thursday that representatives from the International Monetary Fund (IMF) had walked away from talks.
There is a belief in the market that a Greek default and an exit from the Euro can happen in an orderly fashion. In other words, we should not expect a Lehman’s type moment, a disorderly collapse that triggers a meltdown in the financial system. However, while in theory the authorities might be able to conceive an orderly Greek exit, the reality may be different. The Germans are willing to make an example of Greece to impose fiscal discipline on other member states, just as was the case with the failure of Lehman Brothers as authorities sought to address moral hazard. The lesson learned from 2008 is that in a complex interconnected financial world, the contagion effect reaches far beyond ground zero. This should not be forgotten.
There is also a view that a Euro currency could be stronger without Greece, backed by member states more willing to abide by the union’s fiscal rules. However, one should remember the words from ECB President Mario Draghi, in a November 2014 speech entitled “Stability and Prosperity in Monetary Union”. “If one country can potentially leave the monetary union, then this creates a replicable precedent for all countries. The euro is – and has to be – irrevocable in all its member states, not just because the Treaties say so, but because without this there cannot be a truly single money.”
Draghi earned himself the nickname “Super Mario” for preserving the Euro. His “do whatever it takes” pledge in 2012 to save the Euro has become part of market folklore. However, a Greek departure from the Euro would be testament to the limits of his powers, and raise serious question marks over the credibility of institutions like the European Central Bank. We are now dealing with a known unknown!