The Butterfly Effect and the Kick the Can Corollary
Tim Phillips, CEO – Phillips and Company
How can a country with 11 million people and 300 billion in GDP take down the world? Since Greece's troubles reared its ugly head, European and Asian markets are down 9-15% for the month. The US has fared slightly better, but still down 7% month-to-date.
Greece has defaulted 5 times since 1800, this would be the 6th time in about 200 years. It seems inconceivable that a country with less than half a percent of the global GDP can rattle the global economy.
Well, let me attempt to try to outline the process for how "A butterfly can create a hurricane" as suggested by mathematician Edward Lorenz.
2. Once Greece got into the EU they gave up their currency, the drachma, for the more stable currency, the euro.
3. A more stable currency led to lower interest rates, enabling them to borrow hundreds of billions of dollars from the European Banks and the ECB to fund their massive socialist agenda.
4. This put their economy on an unsustainable path. As long as they had access to low interest rates they could continue to rollover and service debt.
5. Once the global recession began, Greece’s already weak economy got even worse.
6. No one in the private sector wanted to lend to Greece once it was apparent they had no way to pay back the money they borrowed or even make the interest payments.
7. Greece had to resort to public funding from the IMF and the ECB. However, they could only get these funds if they agreed to certain austerity conditions.
8. The government of Greece agreed to these terms last year and they continued to receive funding from the IMF and the ECB.
9. Earlier this month, the Greek Government that had initially agreed to the austerity conditions has been voted out by their citizens. It’s no surprise that the Greek people don’t want to adhere to austerity measures put in place by other countries.
10. One year later, Greece and the European Union are right back where they started. Greece still needs money, and the EU still has no formal way for any country to leave the European Union. This is where the Butterfly begins to create the hurricane.
11. If somehow Greece is to be the first country to leave the EU; then the likely first step would be to print new currency. This would involve converting all of the current euros back to drachmas. They would need to set a conversion rate to do this conversion. Then the currency markets would likely devalue the newly minted drachmas by 40-50%+.
12. This would convert all of the debts owed by the Greek Government into the newly minted, and near worthless, drachmas. Greece would effectively print enough drachmas to pay off all of their debt and pay for continuing basic services.
13. The European banks, the IMF and the ECB would have to accept the near worthless drachmas as payment leading to massive write downs and losses.
14. The European banks would then begin selling off the debts of other troubled countries (Italy, Spain, Portugal, etc.) to mitigate these types of losses going forward.
15. The weakness of these banks would certainly choke off lending to legitimate companies in Europe and Emerging Markets. Remember, most emerging market debt comes from European banks.
16. In order for the European banks and the ECB to maintain lending, they would likely need to increase liquidity, either through lowering interest rates, or printing more euros. Increased liquidity, could ultimately lead to massive inflation across the European Union.
17. If the ECB doesn’t increase liquidity, Greece defaults, and European banks begin to pull capital from other peripheral countries, the severity of the Eurozone’s recession could escalate quickly.
Greece will hope to leverage this Butterfly Effect scenario, and force the European Union to renegotiate the terms and conditions for getting more funding without a plan to pay it back. The European Union and its banks will probably want to buy as much time as possible in order to prepare their balance sheets for Greece to exit the EU.
Once again it appears the Butterfly Effect will be in full swing, leading to the Kick the Can corollary.
Tim Phillips, CEO – Phillips & Company