Could Greece spark a new European crisis?

As a snap election looms in Greece, political uncertainty is sparking fears of a Grexit. But fears of another crisis are overblown.

Greece looks sets to hold a general election on January 25 after the Greek parliament failed to support the candidate nominated by Prime Minister Antonis Samaras' for president. 

Early in the European session, Greek Stocks had slumped nearly 10 per cent, and while a lot of those losses were retraced, stocks still ended the session off 3.9 per cent. 

For the year, Greek stocks are down between 20-30 per cent. Meanwhile, Greek bond yields spiked again: the 10-year up to 9.63 per cent, or 107 basis points higher for the session -- over 300 basis points since September.

The big fear is that if the Greeks hold fresh elections at this point, voter dissatisfaction with austerity and Greece’s bailout program would see anti-bailout leftists Syriza sweep to power, unleashing a whole new wave of uncertainty. The concept of a ‘Grexit’ is even being bandied around again.

To the extent that Greece threatened the viability of the eurozone back in 2010-12, it seems clear that the probability of severe financial market ructions are much less lower this time around.  

While Greek financial markets have been absolutely trashed over recent months, there has been no sign of a broader contagion, even in the ‘peripheral’ nations such as Spain and Italy. That’s not to say that Italian or Spanish equities are having a great Christmas: stocks in Milan are down about 5 per cent over the past three months, and a few percentage points or so for Spain as well. Yet that isn’t much worse than the Aussie market.

More importantly, Italian and Spanish bond yields haven’t reacted to events in Greece. Recall that the issue for Europe wasn’t Greece as such. Greece is a small nation: 0.5 per cent of the world economy or something like it. The issue was always about contagion into the larger and much more systemically important nations of Italy and Spain. 

Both of those countries were thought to be insolvent as well, incapable of servicing their debts, but this was always wrong. Unlike Greece, which was insolvent, Spain and Italy had a liquidity crisis. A crisis that was sparked by panic -- by fear. Their debts were always serviceable at reasonable rates. The problem was that as the Greek crisis intensified, the market pushed rates for Italy and Spain ever higher. Debt that was serviceable at 3-6 per cent was perhaps less so at 7-9 per cent. In essence, concerns over Italy and Spain were self-perpetuating.

With that in mind it matters a great deal when, as this latest crisis plays out, the Italian 10-year bond yield  sits comfortably at a very low 1.94 per cent -- or about 210 basis points lower than at the start of the year -- and about 50 basis points lower over the last few months. The Spanish equivalent is currently at 1.7 per cent, which is down approximately 220 basis points from the start of the year and 35 basis points since September.  

Debt markets are not rattled, or at least not concerned about contagion. The ECB’s long-term refinancing operations and expectations they will soon conduct QE is no doubt soothing any nerves.

More broadly, the Greek bailout was due to end this month anyway and was only extended by the IMF and EU for a couple of months. Even if Syriza does get in -- and it’s not clear they could manage a governable coalition -- threats they will tear up the bailout conditions and exit austerity are meaningless. The bailout program will likely be ending anyway. Really, the major fear is that Syriza will conduct a wild and unrestrained spending splurge. But then again, who will lend them the money for that? Anyone foolish enough to do that deserves to lose their money.  

As for fears that Greece will exit the eurozone or the EU, it’s often forgotten that Syriza doesn’t propose this and nor does the general populace want it. Greece benefits financially from being in the eurozone and the European Union, which is why few in Greece actually propose leaving. Neither can Greece be forced out. With that in mind, a Grexit remains very unlikely -- if Greece didn’t even get close to it though the 2010-12 crisis (and they didn’t) -- I doubt the probability is any higher this time around.

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