A Greek tragedy – the Euro Marriage

Within the next week or two, the European Central Bank (ECB) will look to start buying government debt as part of previously announced €$1.1 trillion plus stimulus package[i]. In the background, the ECB has warned Greece that it cannot rely on it to help the country with short-term debt – and Greece has a lot of it.

Greece is due to make a €1.5bn repayment of its loans to the International Monetary fund (IMF)[ii] this month. Given that the country will not receive its bail-out cash until April at the earliest, the new Leftist government has already hinted that it may have to delay fulfilling its obligations to the IMF.

Should Greece fail to make its loan repayments, Greece would join an ignominious list of international pariahs and war-torn failed states, and become the only developed economy to renege on its commitments to the Fund in 70 years.

So how did we get here? Why has this union or ‘marriage’ failed so spectacularly?  

Perhaps the following parable is not entirely fair to the euro, but nevertheless the parallels seem striking. Harvard Professor, Kenneth Rogoff puts forward a light-hearted example of this marriage to what has become a very serious global problem.[iii]  

Consider a young couple who is contemplating marriage, but unsure whether to take the big step. So instead they decide to test things out by opening a joint bank account. At first things go remarkably smoothly. Heady with success, they get the inspiration of extending the arrangement to her brother and his sister. Not only do they hope to show their siblings how well they can cooperate, but with four people, the total size of the account reaches the critical threshold needed to receive exorbitant privileges normally accorded to the bank’s larger customers.

Thanks to a cleverly designed constraint to limit imbalances between each sibling’s contributions and withdrawals, the innovative experiment continues to flourish. There is no real enforcement mechanism, but the two sets of siblings are determined to make the arrangement succeed. Forced to interact routinely, the couple and their siblings start becoming closer. They even start having dinners together on a routine basis.

Eventually, the quartet decides that dinners will be even more fun, and the bank will give them an even better deal, if they expand the arrangement. So the siblings persuade a few cousins to join. Pretty soon, their phones are ringing off the hook with family members they have not seen in years. Cousin Kendra, a marginally employed chef with precarious finances, is nevertheless welcomed in hopes she will employ her culinary skills to enrich group meals.

Life is not without its problems. Everyone is irritated at first cousin Nigel, who lives just across the river yet insists on managing his own finances. He is still invited to meals, though his cooking skills are hardly up to Cousin Kendra’s. She, in turn, exhibits little enthusiasm for balancing her chequebook, and the bank sends ever more frequent warnings that her overdrafts would have to be covered by the others. Shortly after joining, a couple other cousins have taken advantage of their new prime customer bank status to buy extravagant apartments with jumbo loans at far lower interest rates than they were ever afforded in the past.

The whole complex scheme seems to survive against all odds until one day things suddenly start to collapse. Despite informal personal imbalance limits, several cousins significantly overdraw their accounts. Others fall behind on mortgage repayments. Panicked, the founding siblings ask themselves whether it might be best simply to kick out the group’s worst behaving members. Unfortunately, the bank informs them this will be very difficult to do without first closing the entire account, wreaking havoc with everyone's finances.

Desperate, the family brings in a well-regarded outside financial advisor. She comes up with the seemingly brilliant idea of a joint credit card, with payments guaranteed unconditionally by all, including the wealthiest cousins. This would allow the impecunious members to pay off bad cheques and mortgages, effectively borrowing against the resources of the others. And it wouldn’t be a gift, the advisor promised. Borrowers would pledge to skip meals. Any savings on ingredients would be used to make loan repayments. This works for a while until cousin Kendra starts to look pale from her diet. She begins missing work and the imbalance between her occasional deposits and frequent withdrawals gets worse. The richest cousins soon find they have to mortgage their houses in order to pledge enough cash to the bank to prevent an immediate collapse.

Of course, this grand experiment ends catastrophically.

The reader is now left in suspense as to whether the couple gets married. Perhaps the parable overstates the risks fully independent countries face when sharing the same currency, but then again, maybe not by so much.

The real lesson of the euro’s grand experiment is that, given the weak state of global governance, the optimal single currency area is probably still a country, at least when two or more large countries are involved. A pre-nuptial joint bank account is a very unstable route to marriage.

Financial Keys is of course watching events unfolding in Europe and across the rest of the world including our very own backyard and make every effort to ensure client portfolios and strategies are appropriately positioned.

[i] Bloomberg 22 January 2015 [ii] Wall Street Journal 2015 [iii] Financial Times 24 April 2012