Will Greece Exit the Eurozone?
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With Germany's leaders telling us that the exit from the Eurozone by Greece no longer holds terror for them, we understand that they are prepared for such an eventuality. As the E.U. leader's representatives went to Greece this week to see the progress on the implementation of structural reforms and the austerity measures, it became clear to all that while we must wait for the results from them, Greece is failing in its efforts and further financing will be held beck for now, at least. Adding to the woes in Greece, there is little agreement within their Parliament. The Greek government is itself a broad mix of conservatives and Socialists.
In turn, the leaders of the European Commission, the International Monetary Fund and the European Central Bank, known as the troika, are increasingly divided among themselves. That is creating even more uncertainty as Greece and the rest of Europe head for yet another showdown, renewing doubts about how long Athens can remain within the Eurozone.
Greece's lenders say they will not finance the country any further unless it meets its goals. But many experts say that the targets were never within reach and that pushing three increasingly weak Greek governments to comply has only profoundly damaged the economy. The belief in many quarters including in the Finance Ministry in Germany is that the exit of Greece from the Eurozone is almost certain now.
Officials from the troika overseeing the Greek bailout, the International Monetary Fund, the European Central Bank and the European Commission in Brussels, say privately that they doubt the country will be able to meet its official target of bringing its debt down to 120% of economic output by 2020. Greece must make the €3.1 billion in bond payments to the central bank on Aug. 20.
The European Commission reaffirmed that the next tranche of aid to Greece would probably not be disbursed until September, putting the country at greater risk of running out of money to pay salaries and pensions.
At the end of last week, the European Central Bank cut off a crucial source of cash for Greek banks, saying that it would stop accepting Greek government bonds as collateral for low-cost loans until the E.U. completes its report, which is not expected until late August at the earliest. Greek banks must now borrow from the Greek Central Bank at a higher interest rate, from a fund with limited means; if it runs out Greece would have to start printing drachmas.
The IMF, which indicated in March it won't commit more money to Greece, will make a decision on its next disbursement in late August at the earliest based on the troika's findings, said two fund officials familiar with the situation in recent days. The IMF has signalled to European officials that it will stop paying further rescue aid to Greece, bringing the country closer to insolvency in September. It's "already clear" to the E.U. that Greece won't reach the 120% target. Missing the targets means Greece would need between €10 billion and €50 billion in additional aid, a potential outcome that the IMF is not prepared to accept. The possibility that Greece could exit the 17- member monetary union has been voiced this year by European officials who consider the fallout from such a scenario would be the lesser evil against a seemingly perpetual crisis.
Greece's economy shrank 3.5% in 2010 and 6.9% in 2011 and is expected to contract 7% this year, a decline reminiscent of the Great Depression of the 1930s. Unemployment is at 22.5% and expected to rise to 30%, while Greece's main retailers' association warned on Monday that sales were expected to drop 53% this year.
Greece, which held consecutive elections in May and June as public opposition to spending cuts grew, risks running out of money without the disbursement of €4.2 billion due last month as the first instalment of a €31 billion transfer.
The statements above and the increasingly 'anti' stance against Greece brings its exit to center stage. So it is sensible to look at what happens to it 111 tonnes of gold it holds in its Gold and Foreign Exchange reserves currently.
Where's Greece's Gold?
The 111 tonnes of gold owned by Greece is in one of three central banks and perhaps spread throughout the three. These banks are the Bank of England, the Banque de France and the U.S. Federal Reserve. We are of the opinion [the Bank of International Settlements would never disclose the facts] that Greece's gold was first used in some of the over 500 tonnes of gold/currency swaps executed two years ago and unwound last year by the B.I.S.
We believe, further, that these swaps were undertaken by nations finding it difficult to raise new loans at reasonable interest rates. The gold/currency swaps were undertaken as part of the collateral creditors required to facilitate new loans. As such their value went far beyond the market price of the gold involved.
When Greece required a generous bailout from E.U. creditors we were led to believe that part of the collateral, to be forfeited on default, was the 111 tonnes of gold owned by Greece. It is this gold that is now in danger of being lost to the nation now.
The fact that it is not in the country has allowed it to be possessed by central banks outside the country that would not hesitate to hand the gold over, on default by Greece.
Why a Nation's Gold is Not Held at Home
It may come as a surprise that the bulk of the world's central banks do not hold their nation's gold in vaults at home. It has been this way for most of the last century. While the reputations of the three central banks are impeccable, nevertheless, with the world in the financial state it is in now, it seems a matter of prudence that gold should not be in the possession of foreign central banks. After all when push comes to shove, possession is nine tenths of the law.
This became a worry last year to Venezuela who is not the darling of the U.S. at the moment. Its gold was held in several central banks, including the bank of England. President Chavez, on the advice of his central bank decided to repatriate Venezuela's gold. It was a cumbersome exercise but it was done and is now held in Venezuela out of the reach of those unhappy with its nationalization policies. After all there is always a case to be made for creditors whose assets have been seized to be given recourse to the country assets held outside the country. This is an increasing danger in a world where the value of sovereign debt is in doubt in so many countries.
One of the key reasons for holding gold is to be able to sell it to provide the nation with access to international trade and loans, when its creditworthiness and its currency are unacceptable outside the country. By holding the gold outside the country that gold may well have been appropriated by other nations. We have seen of late this happen to Iran, all of whose foreign assets have been frozen with attempts being made to freeze its oil exports. Whether justified or not, the vulnerability of a nation's assets should be a factor considered by the government and central bank of every nation. To allow their assets to be vulnerable to seizure is an act of imprudence to say the least.
Should Greece forfeit its gold as a consequence of its default, then it will be, we expect, at market prices only. The ability to use its value far above its price by way of collateral in gold swaps to facilitate loans and lower interest rates will have been lost entirely. We believe that it is part of a central banker's duty to handle their nation's assets to the full benefit of the nation. That requires that the gold be in its own possession not in the hands of others who may seize it because of a policy disagreement no matter how serious it may be perceived.
If Greece Leaves Then What Next?
Greece will, we believe have to leave the European currency entirely, just as Argentina did in the nineties. After all, the massive loss of creditworthiness will necessitate a devaluation of the currency. That won't happen by continuing to use the euro. A glance at history shows that in this case it is possible that a value of 50% of the Euro be attributed to the Drachma. In addition there will have to be a block put on capital exports from Greece. After that we would expect to see a "Financial Drachma" [ort whatever name the Greek central bank gives it] in addition to a "Commercial Drachma" instituted in Greece as Capital and Exchange Controls are put in place to protect what's left of the financial viability of Greece.
The "Commercial Drachma" would be used for normal trade activities of import and export of good and for tourism. The "Financial Drachma" would be for capital flows both in and out of the country. We may well go into more detail once these events have happened, but for now let's leave it as a currency that could easily fall by another 30% against the "Commercial Drachma" [say 35% of the exchange rate value of the euro]. In another article, we may well paint the huge advantages to Greece of operating such a system.
In addition we may well see a system of "debt Conversion" being instituted within Greece to incentivize investment into Greece for infrastructural development and other projects that would benefit the nation.
Julian Phillips
Gold Forecaster
