At an emergency meeting held last Thursday, European leaders agreed on a €109 billion new aid package aimed at alleviating the financial burden Greece has been suffering from for almost two years now. This déjà vu rescue package puts a temporary end to months of confusion and sterile debates between Eurozone political and financial leaders who have demonstrated their inability to tackle what is at the roots of the crisis, namely major political and economic discrepancies between 17 countries sharing a common currency.
This recent measure, however, is slightly different from previous interventions, in that private debt holders, pressured by Merkel, have accepted to contribute to this joint effort. Although this has somehow eased the pressure on Germany and France, it is also the first official sign that Greece is defaulting, considering that the terms of the debt have been modified: credit rating agency Moody’s has just cut Greece’s sovereign rating to the grade “Ca”, explaining that the recent EU efforts imply that the probability of default on the country’s government bonds is “virtually 100%”.
Then, this new bailout is just a way for European leaders to buy more time in order to find a long-term, sustainable solution to a much more complex problem: while Greece is being bailed out for the second time in two years, the world is keeping a close eye on Italy’s worsening financial situation, whereas Portugal, Ireland and Spain are still in the pipeline for additional financial aid. And with no political control over the Euro, none of these countries seem able handle their financial burden without external help. Let the figures talk for themselves: Greece’s debt is reaching levels close to 150% of the country’s GDP, while Italy and Ireland are flirting with 120% of their GDP. And if these numbers are not enough to convince you that the European currency might be living its last weeks or months, just compare them to Argentina’s debt-to-GDP ratio of 65% before it defaulted in 2001…
So given this uncertainty, how can you measure the exposure of your portfolio to the Eurozone crisis, and what are the best ways to and hedge your positions accordingly? We, at HiddenLevers, believe that the thorough analysis of all possible outcomes of a macroeconomic context is the most effective way to mitigate macro-risk, and in this case, we have identified three possible scenarios as realistic outcomes of the crisis:
Under this optimistic scenario “a la General Motors”, European leaders would find a way to efficiently manage Greece’s default and avoid a contagion to other indebted European countries. Greece would remain in the Eurozone, giving a strong example of fiscal and budgetary austerity to the other PIIGS. As a result, the Euro would strengthen while investors and consumers’ confidence would be restored.
This is the situation under which Greece would be forced to leave the Eurozone and start printing its own devalued currency as a means to prevent the contagion of the crisis to other countries. As a consequence, the Euro would suffer a slight correction on the short-term, but no long-term shock should be felt in global markets.
This worst-case scenario “a la Lehman”, corresponds to the failure of European leaders to contain the contagion that would spread over the PIIGS nations, falling out of the Euro and being forced to go back to their own currencies. The subsequent run on the Euro would lead to a severe depreciation of the common currency, and signal the beginning of a new major global economic downturn.