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  • Jochen Felsenheimer

Greek tragedy.

(Reading time: 2 - 4 minutes)

Jochen Felsenheimer is Managing Director of XAIA Investment and reflects on the long-term consequences of the policy change in Greece.

Everywhere on the markets there is wild speculation about the effects the shift to the left in Greece might have on the European financial markets. And it's not that hard to judge. After all, the economic facts have been known for several years.

It is highly unlikely that Greece will be able to service its liabilities in the coming years without monetary transfers. The necessary primary surplus in the Greek state budget will be even more difficult to achieve if Syriza implements the relaxation of the austerity programme announced in the election campaign. If Europe does not succeed in initiating further aid measures, only a further restructuring of the Greek debt can reduce current interest costs and create a balanced budget. Otherwise, Greece will go down in history as the country that suffers two defaults in a very short time.

The Greek situation will therefore remain difficult and I assume that a Grexit - a withdrawal from the European Union, a singular withdrawal from the euro zone is not possible - will be discussed for even longer as a potential measure. The still inefficient administrative structures and the manageable success of the austerity measures - at least in relation to the challenges - indicate that Greece will continue to play the role of the sword of Damocles in Europe.

Still, everyone seems relaxed. Der Grexit, it is said, is controllable. Maybe so. I don't want to overstretch the findings of the crisis literature. What is important, however, is the distinction between first round effects and what happens in the second or dritten Runde.

In the first phase of financial crises, negative effects occur in one market segment - for example, the losses in the US subprime market in 2008 caused by the decline in house prices in the USA. These remain very limited. Second round effects - the market reactions to the collapse of the subprime market such as falling share prices, widening credit spreads and the dysfunctionality of the interbank market - cause much higher losses. This phase is followed by third round effects that affect the real economy, such as a decline in growth or rising unemployment. These third-round effects account for the largest share of the costs caused by financial crises.

Now the first round effect of a Grexite is actually manageable. The problem is the second and third round effects. Special treatment for Greece provides an argument for all peripheral countries to want to make use of it. The already growing number of opponents of a strict austerity policy feel confirmed that it is inefficient and thus have less incentive to implement further structural reforms.

At the same time, with the announcement of the bond purchase, the ECB is opening up an extremely pleasant way of refinancing for its member states - it seems difficult to imagine how a noticeable reduction in debt levels could succeed in this environment. I don't want to sound cynical, but I think I can remember that the trigger for the European debt crisis was too high a level of debt combined with extremely low interest premiums - which was what made this level of debt possible in the first place - in the peripheral countries.

Of course, the ECB's measures will have a positive effect in the short term. In addition to stock markets at record or multi-year highs and extremely low yield levels, the refinancing costs of peripheral countries are also at their lowest level since the introduction of the euro. But is that the right incentive? The peripheral countries will tend to save less, incur more debt and thus create precisely the environment in which an increase in refinancing costs will have to trigger the next debt crisis at some point in the future.

It seems unlikely that this will be the case as early as 2015. But don't be fooled. The path taken by the ECB is anything but stability-enhancing in the long term.

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