How Do You Protect Your Wealth Against a Greek Doomsday Scenario?

February 23 2015

I still suspect, like the market does, that a last-minute agreement will be reached between the new Greek government and the Eurogroup. However, every passing minute also means that a potential failure may very well lead to a definitive Grexit. If anything goes wrong, it will be too late to smooth out the differences. The Greek government will run out of liquid funds in about a week. 

How Do You Protect Your Wealth Against a Greek Doomsday Scenario?

I still suspect, like the market does, that a last-minute agreement will be reached between the new Greek government and the Eurogroup. However, every passing minute also means that a potential failure may very well lead to a definitive Grexit. If anything goes wrong, it will be too late to smooth out the differences.

The Greek government will run out of liquid funds in about a week. In that case, they can keep bills left unpaid and thus postpone a bankruptcy (an official default). However, estimates show that the Greek have little leeway. Germany would like the markets to believe that a Grexit would not have major consequences for the future of the euro, but nothing could be further from the truth.

Spanish and Italian Interest Rates Are Declining (!)

Four years ago, ‘’contagion risk’’ was still a real problem. While Greek interest rates were rising, investors began to worry about other highly-indebted countries as well. As a result, interest rates on Spanish and Italian government bonds has risen strongly.

Given the current turmoil in Greece, we may logically assume that this scenario will happen once more. Yet, the opposite is happening. Despite all the fuss about Greece, interest rates on Spanish and Italian government bonds are declining. Apparently the over-indebted peripheral countries are suddenly ‘safe havens’ as well.

Are those declining interest rates in the peripheral countries justified? I can assure you: they are not. Last week Pabo Iglesias, leader of the Spanish anti-Europe party Podemos, said that he wants to ‘restructure’ over €900 billion of Spanish government debt (in others words, not repay them). It is very likely that Podemos will win the next Spanish elections.

What Are the Direct Consequences of a Grexit?

The consequences for the Greek are clear. A Greek exit of the Eurozone, means a return to the drachma. A return to the drachma will be accompanied by the introduction of currency controls. However, this will not prevent an enormous devaluation. The Greek will collectively buy foreign currencies (on the black market) and real goods in order to protect themselves against further devaluations. The drachma will instantly be faced with a currency crisis.

It is evident that Greece will no longer repay its debt (to, among others, the ECB, IMF and the other European countries). This will not ruin European banks, but such a bankruptcy would lead to large protests in, among others, Germany. Future financial support to other European countries would become a problematic and very unpopular decision for all politicians in Western-Europe.

Nevertheless, the exposure of European banks and the Dutch pension funds is virtually non-existent. The direct consequences of a Grexit are thus limited.

The Indirect Consequences: The Comeback of “Contagion Risk”

The indirect (secondary) consequences are much far more important to you.

Even though interest rates on government bonds are declining in all other European countries, the anti-euro sentiment in Spain and Italy will not disappear. Rather, the anti-euro sentiment is very much alive and will further strengthen when Greece exits the euro and refuses to repay its debt.

A likely scenario is that this anti-euro sentiment will lead to electoral victories of populist opposition parties. Currently, the polls indicate that opposition party Podemos would get around 25% of the votes, and thereby be the largest party by a small margin. Or consider the statements from Beppe Grillo, the opposition leader in Italy. Past Friday, he wrote that “the euro will vanish into thin air” and points the finger at Germany.

Currently, interest rates on Italian and Spanish government bonds do not account for a return to the lire and the peseta. As soon as a Spanish and Italian exit becomes a possibility, we will see rising interest rates there as well. And that does have major consequences; a return of “contagion risk.”

Naturally, it may also happen that the ‘Greece’ scenario that I describe above, will lead to a knee-jerk reaction in countries like Spain and Italy, causing the support for anti-euro parties to vanish.

What Does a Grexit Mean for Your Wealth?

Although Dutch banks have almost no exposure to Greek government bonds and commercial bank debt, this does not apply to countries like Spain and Italy. The exposure of Dutch banks, pension funds and other financial institutions to the other peripheral countries is several times larger than the exposure to Greece.

Consider the Spanish and Italian commercial banks for example; these have the largest European government bond holdings in history. 10% of total commercial bank assets are European government bonds. In Italy, for example, domestic government bonds are mainly held by national commercial banks. If interest rates on these bonds rise, and bond prices correspondingly drop, such a large exposure may make the already -little equity capital of those banks vanish into thin air. 

The result? A European banking crisis.

This means that your savings are at risk, while you are receiving a mere 1-1.5% interest on your savings. For many this means a loss of purchasing power, given inflation and capital gains taxes, aside from being exposed to a potential European banking crisis. I probably do not have to mention it, but a negative return (!) does not constitute an adequate compensation for the aforementioned risks.

Let it be clear that this time European governments, in particular those of the PIGS countries, will not be able to bail out their banks, and recapitalize them with public money.

A Grexit may also trigger a market crash. As we have discussed before; stock markets are highly overvalued. Even the slightest disturbance may provoke a spiral of falling stock prices and result in major losses for you, as an investor, and your pension funds. As already can be seen from the market’s reaction; a Grexit, a Greek banking crises and higher interest rates in the European periphery will be enough to unleash a strong correction of stock market prices.

How To Protect Your Wealth

It thus seems wise to secure a part of your wealth in gold and/or dollars (no U.S. stocks). Considering the extreme sentiment, it is plausible that the euro will be able to strengthen relative to the dollar. However, it is quite likely that within the next one or two years the dollar will once again turn into an international safe haven. The EUR/USD exchange rate may even decline to parity. U.S. interest rates could decrease to German or Japanese levels.

Gold does not necessarily have to stay behind. On the contrary, gold could even outperform the dollar, considering the dollar already appreciated significantly (more than gold). The supposed (negative) correlation between gold and the dollar is a frequently stated chimera that will not have to apply in the coming years.

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