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Wednesday 15 August 2018

Greece, Ireland and the euro: 12 things I think will happen next

The failure of the ECB to agree a second bailout package for Greece kicks off a high-stakes game of chicken that could up blow the eurozone apart. Let's look at what could happen next.

1 With the ruling PASOK party split down the middle, the main opposition New Democracy vehemently opposed and riots in the streets, Greece fails to pass the draconian spending cuts, about €28bn, and privatisations, about €50bn, being demanded by the EU.

2 In return the EU refuses to release the €12bn it had been due to hand over next month under the current bailout programme.

3Following Greece's failure to approve even more savage austerity measures, the EU also refuses to sign off on a new €100bn Mark II bailout package, which the country desperately needs to stave off a debt default.

4 Greece defaults on its €340bn of sovereign debt, about 150pc of GDP. This will be the first debt default by a Western European country since the immediate aftermath of the Second World War.

5With the Greek banks large holders of Greek government bonds, a debt default would leave the banks effectively bust. In order to avoid a "run" on the Greek banks the Greek government would have to reintroduce capital controls, restricting the amount of money depositors could withdraw from Greek banks and the amount of money they could take out of the country.

6 Following a debt default and the re-imposition of capital controls Greece leaves the euro. Initially this will be a messy and disorderly process with the new drachma losing at least 40-50pc of its value against the rump euro.

7 At least one French bank goes bust. The big lenders to Greece have been French and German banks, which is why the ECB has been desperate to avoid a Greek default. The latest figures from the Bank for International Settlements puts the exposure of the French banks to Greece at $57bn and that of the German banks at $34bn.

8The contagion spreads to Ireland and Portugal. If one of the peripheral eurozone countries goes bust why not the others? Last week investors were pricing in a 38pc "haircut" on Irish government bonds over the next five years and a 39pc "haircut" on Portuguese government debt.

9The pain spreads to Spain. The EU and the ECB could probably muddle through crises in Greece, Portugal and Ireland. The big one is Spain. With almost 20pc of eurozone output it is both too big to fail and too big to bail out. Spain's property bubble was second only to Ireland's and while its banks have weathered the storm up to now the news that 11 members of the Botin family, which controls Spain's biggest bank Santander, had been placed under investigation for tax evasion, will have done nothing to calm the market's fears.

10 The eurozone breaks apart. If the crisis spreads to Spain it's all over. The eurozone won't survive in its current form if Portugal, Ireland, Greece and Spain leave the euro. They could be followed by other eurozone countries, most likely Italy.

11The economies of the eurozone defectors recover strongly. Freed from the shackles of the eurozone's fixed exchange rate regime, the currencies of the PIGS would fall sharply on foreign exchange markets. This in turn would make exports highly competitive and trigger economic recovery.

12The economies of the remaining eurozone countries fall into a deep slump. With the PIGS now being much more competitive, France and Germany would find the going much, much tougher in export markets. With exports down and their banking systems in deep trouble their economies would grind to a halt. Couldn't happen to a nicer bunch of people.

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