''GREXIT''

 

WHAT HAPPENS HERE IF GREECE EXITS THE EURO?

 

Another downturn? Or something much less severe?
 

 

June 5, 2012

 

 

If Greece leaves the eurozone in the coming months, what kind of financial ripples could reach America?

 

 

Nobody can predict the endgame yet; Greece may even stay in the euro, although that is looking less and less likely. The big concern isn’t what happens in Greece – it is about what could happen in Spain or Italy as a resultof what happens in Greece.

 

The effects from a Greek default (and eurozone exit) would likely be felt on four fronts in America – but first, an economic chain reaction would almost certainly play out in Europe.

 

 

A Greek default could imperil Spain & Italy. If Greece leaves the euro, then Greek bondholders lose their money. A crisis of confidence in the euro could prompt institutional investors to either walk away or demand even higher interest rates on Italian and Spanish bonds. The European Central Bank could then step up and provide emergency lending, bond buying and recapitalization efforts. If those efforts were to fall short, the worst-case scenario would be a default in Italy and/or Spain.

 

 

It could also hurt U.S. banks that aren’t sensibly hedged.If Italy and/or Spain default, a severe downturn could hit EU economies and U.S. lenders would be looking at a huge potential problem. If they are capably hedged against the turmoil in the EU, they could possibly ride through it without a lot of damage. If it turns out they have made foolishly speculative bets (cf. Lehman Brothers, JPMorgan), you could have a big wave of fear, which in the worst scenario would foster a credit freeze reminiscent of 2008. Would the Fed step in again to unfreeze things? Presumably so. Without its intervention, you could have a Darwinian scenario play out in the U.S. banking sector, and few economists and investors would see benefit in that.

 

 

The good news (relatively speaking) is that U.S. banks have cut their exposure to Greece by more than 40% as that country’s sovereign debt crisis has unfolded. Pension funds and insurers have joined them.1

 

Stocks could fall sharply & the dollar could soar.The greenback would become a premier “safe haven” if foreign investors lose faith in the euro. At the same time, a crisis of confidence would imply big losses for equities (and by extension, the retirement savings accounts and portfolios of retail investors).

 

 

U.S. companies could be hurt by fewer exports to Europe.Right now, 19% of U.S. exports are shipped to EU nations. If a deep EU recession occurs, demand presumably lessens for those exports and that would hurt our factories. If institutional investors run from the euro, it would also make U.S. exports more costly for Europeans. Additionally, the EU is the top trading partner to both the U.S. and China; as Deutsche Bank notes, the EU accounts for 25% of global trade.2

 

 

Our recovery could be hindered.Picture higher gas prices, a markedly lower Dow, the jobless rate increasing again. In other words: a double dip.

 

 

In mid-May, economists polled by Reuters forecast 2.3% growth for the U.S. economy in 2012 and 2.4% growth in 2013. These economists also believe that were the fate of Greece not on the table, U.S. GDP might prove to be .1-.5% higher.2

 

 

If politicians play their cards right, we may see better outcomes.For example, Greece could elect a new government that decides to abide by the requested austerity cuts linked to EU/IMF bailout money. Greece could remain in the EU and banks in Spain, Italy, Germany and France could ride through the storm thanks to sufficient capital injections. Global stocks would be pressured, but maybe on the level of 2011 rather than 2008. (Maybe the impact wouldn’t even be that bad.)

 

 

In a rockier storyline, Greece becomes the brat of the EU – a newly radical government rejects the bailout terms set by the EU and IMF, Greece leaves the EU and starts printing drachmas again. The EU, IMF and maybe even the Federal Reserve act rapidly to stabilize the EU banking sector. Early firefighting by central banks results in containment of the crisis after several days of shock, with U.S. markets recovering in decent time (yet with investors still nervous about Italy and Spain).
 

 

Containment may be the key.If a Greek default can be averted or made orderly by the EU and the IMF, then the impact on Wall Street may not be as major as some analysts fear – and who knows, the U.S. markets might even end up pricing it in. Greece only represents 2% of eurozone GDP; our exports and credit exposure to Greece are minimal at this juncture. Our money market funds have mostly stopped investing in Europe. So with diplomacy and contingency planning afoot, a “Grexit” might do less damage to the world economy than some analysts believe.2

 

 

What Should You Do Now?Sit tight and hold on! We have been positioning clients’ portfolios defensively for some time due to our concern about the Eurozone. We will continue to monitor this situation very closely. As always, give us a call if you have questions or want to discuss this further.

 

 

Sincerely,

 

Edward J. Kohlhepp, CFP®, ChFC, CLU, CPC, MSPA

Edward J. Kohlhepp, Jr., CFP®, MBA

 

http://www.facebook.com/pages/Kohlhepp-Investment-Advisors/143204745739600

 

Please contact us whenever there are any changes to your financial situation, personal situation or investment objectives.

 

 

 

 

 

Citations.

www.marketinglibrary.net

1 - www.csmonitor.com/USA/Latest-News-Wires/2012/0514/Greece-s-economic-woes-may-hurt-US [5/14/12]

2 - www.cnbc.com/id/47562567 [5/25/12]
 

 

CAN WE AVERT THE FISCAL CLIFF?
The Run that Wasn't

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Kohlhepp Investment Advisors, Ltd.
3655 Route 202, Suite 100
Doylestown, PA 18902
Phone: 215-340-5777
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