Merryn's Blog

Why the cost of letting Greece go is just too high

One 'solution' to Greece's sovereign debt crisis is for the country to leave the eurozone. But the consequences of that would be very unpleasant indeed.

I'm in Madrid having a look around. Yesterday we met with the management of four different medium-sized companies. They all operate in entirely different sectors, but they all told us pretty much the same story.

The first part is that times are tough in Spain. Contracts - and particularly public sector contracts - are hard to come by. Competition from companies "desperate to survive" is pushing down the price you get, even if you land a deal at home. Revenues and margins are squeezed.

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The only good news is that it is easy to hire - and on falling levels of real wages too. Three years ago you couldn't find good people to work for you. Today you can take your pick from a pool of perfect workers. It feels like deflation.

But that's not the end of the story. The second part is how these companies are expanding and surviving: emerging markets. They are making acquisitions in the likes of Brazil and India (not China - it is, as two companies told us, "too hard") where the conditions are the exact opposite of those at home.

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There is fast inflation. Prices have to be reviewed every three months. Staff are hard to come by and expensive. they also leave a lot: one company told us their staff turnover was 20% plus every year. These are risky places to operate, but they do at least "come with enough opportunity for everyone" as one company representative told us.

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No great surprises there. Nor in the things that the companies mainly listed as risks. Most we were pretty frank. They noted that the Spanish misery could drag on for some time; that the coming election could result in another nasty round of austerity; that competition and rising taxes could drag their margins down even further; and so on. But one thing no one mentioned as a risk was the collapse of the euro.

Should they? GFC's Graham Turner certainly seems to think so. He sees last week's resignation of Jurgen Stark - the chief economist at the ECB - as a "watershed" that has blown "wide open" the domestic debate in Germany about whether to save the peripherals from default.

The fact is that the German position is not softening, and the rising opposition in the country does increase the "very real risk" that Greece, and consequently others, will be forced into default. "Bond operations only work when there is unanimity." And there is not. There is a rising swell of opinion that reckons that "letting Greece go" would be the best way out of this mess.

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We suspect that, tempting as it is, it wouldn't be. James Ferguson addressed the horrors a Greek departure would offer to the European banking system in the magazine a few weeks ago. But now UBS has quantified what it believes would be the actual cost per person of a break up (which is inevitable unless there is a move towards fiscal confederation very quickly).

According to their analysts, the departure of a weak country from the euro would lead instantly to a range of nasty things including sovereign default (as euro debt is forced into the new currency), corporate default, the collapse and eventual recapitalisation of the banking system, and the collapse of international trade.

The whole thing would end up incurring a cost of around €9,500-€11,500 per person in the exiting country in the first year (40-50% of GDP) and around €3,000-€4,000 in the following years.

But that's just for the one departure, which is unlikely. The first is bound to prompt a few followers (if Greece went and you had money in a Portuguese or Spanish bank would you leave it there?). So you have to think of these numbers as starter numbers.

Finally it is worth noting, as UBS does, that "monetary union breakups in history have nearly always been accompanied by extremes of disorder or civil war". This isn't the kind of thing that most companies like to add to their lists of operating risks (and UBS is convinced that Europe will go for confederation rather than civil war).

But still, something to bear in mind if you were thinking of picking up some cheap European stocks.




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