Jeremy Siegel: How a ‘Grexit’ Could Strengthen the Eurozone

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Jeremy Siegel discusses what the Greek debt crisis means for the U.S.

The debt crisis in Greece is quickly turning into a Greek tragedy. Banks have closed for a time, ATMs have cash limits and the stock market has not opened. Greece’s bailout expires on June 30, the same day its $1.8 billion debt payment is due to the International Monetary Fund. Greece reportedly will not pay it. Prime Minister Alex Tsipras has called for a July 5 referendum on the latest bailout terms by the IMF, the European Central Bank and the European Commission.

While the situation is dire for the Greeks, Wharton finance professor Jeremy Siegel says the crisis will likely be contained because of freer lending to banks in other countries. And if Greece does exit the European Union, he believes it will strengthen the eurozone. Siegel points to the euro gaining ground even as news of Greek bank closings led to expected declines in the European capital markets — which were to a lesser extent reflected in the U.S. markets as a result of a flight to quality.

As for the impact of the crisis on the Fed’s intention to raise the federal funds rate later this year, Siegel says the U.S. central bank will take the situation in Greece into account if it continues to be a problem months from now. But he does not believe the debt crisis will present enough anxiety for the Fed to derail an increase in the overnight bank lending rate. Siegel expects the rate hike to come in September.

An edited transcript of the conversation appears below.

Knowledge@Wharton: Jeremy, give us your quick analysis of the situation in Greece and its impact on the markets. What do you think?

Jeremy Siegel: The situation is very serious in Greece. Closing the banks, closing the stock exchange, closing or restricting the ATMs already is having a devastating effect on tourism, which is a very big part of Greek economy. If the banks remain closed for at least a week until the referendum, we could see another sharp rise in unemployment and further decline in GDP. Greek GDP had already declined 25%. It could decline 10% more as a result of the closing of the banks. I believe that [European Central Bank President Mario] Draghi will “ring fence” Greece. Twitter  Although there is no lending to the Greek banks, he will liberally lend to the Portuguese, Spanish and Italian banks to prevent any spreading of this crisis beyond Greece. And as a result, it will be isolated to the Greek economy.

“The Greek people wanted a government that would deal tough with the Europeans, but they did not want a government that would go over the brink.”

I also believe that, given the terrible blow this will deal to the Greek economy, it is actually quite likely that the Greek people will accept the European conditions for the bailout, which were explicitly revealed … by the European institutions. The Greek people wanted a government that would deal tough with the Europeans, but they did not want a government that would go over the brink, and that is clearly what will happen — and has happened — as a result of closing the banks. I believe they will reject the [left-wing] Syriza [Party] and Tspiras platforms, which would likely lead to his resignation [as prime minister], since he is recommending a “No” vote on the referendum. So ultimately, this might be quite good for Greece if they accept the terms of the Europeans. Then the Europeans will start lending again to the banks, the banks will re-open, and a new set of conditions will be in place.

Now, of course, we could ask the question — six months from now will they abide by all of these new conditions? That is yet to be seen, but at least they will have accepted the conditions the Europeans have put forward. That is what my prediction is for the Greek situation.

Knowledge@Wharton: What do you think about today’s rout in the stock markets across the globe — U.S., Europe, and Asia  — and also the flight to quality, with U.S., English and German bond markets up? Also, why should American investors care about Greece?

Siegel: First of all, the effect on the U.S. market has been negative, but not a rout. The S&P is down less than 1.5% — that’s not a terrible day. Europe, of course, is affected more because of its proximity to Greece and the potential of spreading. The flight to quality was expected as people went to the U.S. and German treasury bonds. The surprise is the rally of the euro after an initial sharp selloff, and that [occurred] because if Greece does leave the eurozone, there’s an expectation that the euro would be a stronger currency without the Greeks.

That has attracted a considerable buying during these last few hours, but the reactions of the market are not unexpected, and I believe once the market realizes that Draghi will step up and provide funding to the other EMU [Economic and Monetary Union] banks, that we will see a recovery in the markets.

“I worry about potential civil unrest in Greece if the banks remain closed and these restrictions continue.”

We’re also getting a little bit of a negative feedback in the U.S. As you know, the governor of Puerto Rico has declared that he does not think that Puerto Rico can pay its debt. There is a tremendous amount of Puerto Rican debt that is held by Americans. This is a negative development, although not totally unexpected. So the reaction in the U.S. markets is muted, and I don’t believe that this will spread to a general decline.

This is, as I say, a very devastating development for Greece. Closing the banks and restricting ATM machines is going to deal a devastating impact on their economy. I worry about potential civil unrest in Greece if the banks remain closed and these restrictions continue.

Knowledge@Wharton: What about the impact on the Fed’s decision to potentially raise rates later this year? They have an eye towards Europe and Asia’s growth.

Siegel: If the Greek situation is still presenting anxiety in the market, then yes, they will take that into account. But I do not expect that to continue to be a source of anxiety in the market. In fact, if the Greeks accept the referendum or Tsipras himself turns around, we actually might get a better situation. But I still think we are on target for a September increase in the [Fed] funds rate, and I don’t think this development and my expected outcomes for this development will change that date.

Knowledge@Wharton: You’ve given us some great insight to your view for the short-term and medium-term. Longer term, is this going to be damaging to the euro and to the eurozone project — whether or not Greece stays in or goes out? Britain is talking about leaving. Are investors getting more worried about Europe as a project in general, longer term?

Siegel: I actually think that this might strengthen the euro. We have a rise of almost 1% for the euro [Monday] as people think that it will be a stronger eurozone without Greece. They overextended the countries that could not maintain the criteria, and now, if Greece exits, the remaining countries have accepted the criteria. That makes for a stronger eurozone. Now, of course, the British situation is very different. There, it is not a question of the euro — it’s a question of whether they want to stay in the EU. But whether Greece exits or not, I don’t think this will have any serious consequences for the eurozone. The Greek people themselves express 75% that they want to stay in the euro. The Spanish and Portuguese have similar opinions: For better or worse, they’re in it now and they consider an exit to be far more disruptive. Whether they should’ve gone in in the first place, of course, you could always speculate about, but given where they stand now, they want to stay in it. I don’t think a Greek exit will change that situation or really threaten the position of the euro.

“…You would have a 10% to 20% reduction in incomes, but [Greece] would suddenly become one of the best competitive nations in Europe.”

Knowledge@Wharton: For Greece, at this point, staying in would seem to mean accepting continued austerity that in a lot of ways hasn’t worked all that well for them. That could mean years and years of struggling at this level. How long do you think it would it take Greece to get back to a reasonable amount of unemployment under the austerity measures versus if it chose to exit?

Siegel: Do you mean if they chose to exit and go to a drachma? They would recover faster with a tremendous drop in incomes, because their imports would jump in price and you would have a 10% to 20% reduction in incomes, but they would suddenly become one of the best competitive nations in Europe. So their trade would boom and everyone’s incomes would go down.

It’s a question: Do you want to do it that way, through a devaluation and change in currency? The other way? Don’t forget, Greece was beginning to grow before the Syriza Party took over. Small, to be sure, but growth. Now it’s going down again. Yes, it’s going to be tough. Don’t forget: One has to remember that although 25% is mammoth and that’s how much GDP has gone down in Greece — and Greece likes to maintain that it has suffered far more from austerity than its other European partners such as Portugal and Spain — it’s also true that [Greece] enjoyed by far the biggest rise in GDP after joining the euro. They also had a tremendous boom that was unsustainable. So the situation in Greece is really “easy come, easy go.” They’re not that much worse off than they were before the euro. When all the capital flooded in, there was so much money that they raised workers’ wages and government officials way beyond productivity. And then, of course, when the tide went out, they were totally lacking and all of this had to be worked out and worked back.

So Greece still has some more adjustment to do, and that would be done if they leave the euro through a devaluation which would wipe out 10%, 15%, 20% of real incomes although it would put them in a competitive situation. They’ll begin working again, but for much lower wages in terms of euros from what we’re used to. Or they could decide to stay with the euro, cut pensions, continue to work down wages to reasonable levels, and stay with the system. There are actually pluses or minuses to both, but I think that when faced with the reality, most of the Greeks would accept the latter, which is to stay in the euro with some more austerity. As I said, they were growing, beginning to grow for the first time in eight years before the crisis resurfaced with the election of the new government.

Knowledge@Wharton: You mentioned that you believe the risk of contagion is going to be limited because the other countries have accepted the debt packages. Could you explain more about your thinking behind that? Why do you think the risk of contagion is not that high?

“Don’t forget, Greece was beginning to grow before the Syriza Party took over. Small, to be sure, but growth.”

Siegel: The question is the banks, and the question, I would say is: Are people going to start lining up at Portuguese banks and say, “Oh my God, they may close tomorrow. I’ve got to get my euros out”? That would be a terrible contagion crisis. That’s the way it would work.

Now, what I am saying is that Draghi will say, “Our lending is unlimited, open to all these Portuguese banks. If anyone wants to come and take out their money, they’ll get their money.” That is going to prevent that contagion crisis, and I fully believe that Draghi is ready to move in that direction.

Knowledge@Wharton: What about the possibility of contagion through the bond markets?

Siegel: Well, I mean take a look at the Spanish bonds, I would say the yield on their 10-year is around 237 basis points. It’s less than the U.S. 10-year Treasury. And that’s before Draghi makes the statement — which I’m sure he will — that money will be lent to their banks. So I don’t believe that the bond market will cause a crisis.

Knowledge@Wharton: Are there any things that we should have asked that we didn’t that you would like to add?

Siegel: I was hearing one interview that said, “How can we have a Sunday referendum?” This was from a Greek, because I think they have paper ballots and it takes at least six days to print the ballots. So they don’t even know what question is going to be on them. So there are definitely some technical difficulties of moving towards a referendum as early as indicated. They may overcome them. As I say, the Europeans put out their conditions. All the Greeks have to do is cut and paste that news item onto their ballot and say, “Are these conditions acceptable?” My feeling is at this time — and especially a week from now in the referendum — the Greek people will say, “We will accept these conditions. We’re not happy, but we see the alternative is much worse.”

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