Today all eyes are on Italy, as the latest eurozone crisis comes closer to a head. The markets are understandably cautious, because it is difficult to imagine how Italy can afford to pay even the interest on its debt without a lot of help.
But the sapper in this potential disastrous blow-up of the EU is still Greece, where the population is fighting even the slightest whiff of government austerity measures and the politicians probably don't have the backbone to do the right thing.
“If the politicians succumb to the population's will and Greece defaults on its debt, the ultimate outcome will be a run on the banks,” said George Feiger, chief executive of Contango Capital Advisors Inc., a $3.3 billion
trust company and advisory firm.
As Mr. Feiger sees it, default would move Greece off the euro and on to its own very weak currency.
“As soon as the people in Greece see that the country has its own currency, you'll see a run on the banks and an immediate collapse of the Greek banking system,” he said. “We're looking at the beginning of the biggest bank run in history, and there's nothing in the European Union structure which prevents the situation.”
Part of the horror story of a run on the banks is that it threatens both government and private debt.
On its own, a default by a country the size of Greece, which is smaller than most U.S. states, would not be especially significant. Indeed, Greece is a serial defaulter. The nation has defaulted on its debt on average about once every 20 years going back to 1822, when it gained its independence from the Ottoman Empire.
But as Mr. Feiger summed it up, “What's the difference between Greece and Portugal? Six months.”
And therein lies the rub. Even as Greece holds its hand on the default plunger, much of the concern is already on the next cave-in on the continent.
“The Greek contagion effect has already occurred, and that's why all eyes should be trained on Italy,” said Stephen Wood, chief market strategist at Russell Investments.
Italy, which represents the world's third-largest bond market behind Japan and the U.S., would be the ultimate body blow should its government decide default is a viable option.
Mohamed El-Erian, chief executive and co-chief investment officer of Pacific Investment Management Co. LLC, concurred that Greek debt will be subjected to a major restructuring.
“The only question is whether that is done in an orderly or disorderly fashion,” he said.
Mr. El-Erian also sees Portugal as a more immediate threat than Italy.
But, ultimately, he explained, it boils down to the strength and commitment of Germany's political leadership and the resolve of German taxpayers.
“Germany holds the key to the future of the eurozone, and it needs to make an important and very difficult decision,” Mr. El-Erian said. “Does it opt for a fiscal union of the existing 17 members of the eurozone, supported by greater political integration, or does it opt for a smaller, less imperfect zone?”
