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July 2, 2015

Grexit: Hope For The Worst?

By Lior Alkalay, INO

Are we experiencing the beginning of the end for the euro? For roughly three years, it seems as though politicians have been kicking the can down the road, putting off the apocalypse right at the last minute. And investors in the currency have had their patience stretched to the limit, vacillating between no hope and naivety that the Greek problem had gone away.

After Greece came Spain, Portugal, Italy and Ireland, but while the rest have been able to curb the risk and get a grip on things, the Greek problem has kept coming back. Now it seems that we've reached the end, the moment of truth, what investors have been dreading for the last three years – that Greece will eventually default and leave the Eurozone, and that it will spell the end of the euro. But now that the end has come, it seems as though investors have not only learned to live with the idea of a Grexit but to actually want it. The saying goes that you have to hope for the best and prepare for the worst, and more and more voices are indicating that some institutional investors are now hoping for the worst, for Greece to leave the euro. But why?

Euro Credibility at Stake 

It wasn't that long ago, during the last Greek crisis, that I outlined my biggest conclusion taken from the Latin Monetary Union, back in 1908. Then, as now, Greece was the Achilles heel and it lacked credibility in the Latin Monetary Union until it was dismantled. Now, investors increasingly understand that Greece, with its continuing problems, just keeps eroding the credibility of the euro.

The financial pain from a Grexit could be tough, not to mention the suffering it will impose on the Greek people, but as far as the euro is concerned, it's definitely manageable – now more than before. However, the longer Greece and its malpractices stay in the euro, the more it cuts through the euro's credibility like a knife through salami.

And that's something the euro can't take for long, because if the price for bending the rules proves to be low, other members, such as Italy and Spain, which had to impose tough measures on their own populations at a high political price, will have a hard time maintaining those measures. And if Italy and Spain begin to lose credibility, that will be the end of the story for the euro.

Apocalypse Now or Later?

Let's think for a second – what would a Grexit right now mean? It would mean that any potential apocalypse that would have happened eventually would happen now. And rest assured we'll have a mess, especially considering the political context. Other peripherals, such as Spain and Italy, which have imposed tough measures on their own citizens, want to prove to their electorate that the pain involved in leaving the Eurozone would be unbearable. Then, of course, there is the financial fallout, which might include more stress on peripheral bonds and perhaps even German bonds.

But the pain will be limited. An ugly Grexit would strengthen political unity among existing members, who would want to avoid pain at all cost – and this comes back to the point of political unity. Because political unity is the only way to strengthen the pillars of the euro, and because that unity might only come after the pain of a Grexit, it could actually be the only chance for the euro to survive. Investors who once feared this are now gradually realizing that an apocalypse now might perhaps eventually strengthen the euro and pave the way for the currency to regain its strength, even if it might weaken in the short term and postpone the short-term rebound they were betting on just a month ago.

Courtesy Lior Alkalay for INO.com

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