As of this writing, Greece is on its second bailout. The problem with Greece is that it has so much debt to banks in Germany and other European countries that it has to keep refinancing that debt. In the same way as you would have to refinance your credit card debt if you reach a high enough level, Greece keeps coming back to its financiers. The problem is how many times can it keep coming back before its lenders finally say no?
This is a very important question. It is by no means rhetorical. The reason why financial analysts are worried about this issue is because of the fact that if Greece eventually leaves the European Monetary Union, this is going to send shockwaves throughout the global financial system. While I am totally convinced that the eventuality of a Greek exit has been priced into the value of the euro, a lot of the unintended consequences of such an exit haven’t been taken into full consideration.
You have to understand that depending on how the European Monetary Union handles the Greek exit, this may pave the way for dangerous patterns that will eventually lead to the collapse of the European Monetary Union. It is no secret that European countries that border the Mediterranean tend to manage their finances quite differently from European countries like Germany, which are located in more northerly regions of Europe. While Germans are fiscally disciplined, the Italians and Spanish are nothing but disciplined. However, unlike Greece which has a comparatively small debt footprint, a default by France and Spain can lead to a crushing financial collapse for the European Union.
This is why it’s really important to note how long Germany will remain patient with the Greek financial drama. The Germans are between a rock and a hard place. On the one hand, they don’t want to give an interest rate haircut to Greek debt. This would set a bad precedent for other European countries who may need such an interest rate haircut. On the other hand, they don’t want to be too hard on Greece that this forces Greece out of the European Union. I’m convinced that Germany and other creditor countries really don’t have too many options on the table.
The best approach would be to let Greece get a graceful exit and devalue its new currency to get out from under its debt. Otherwise, we’re just simply extending the pain and blowing up a greater bubble that when it bursts, it is sure to hurt not just European Union countries but global investors as well.
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