The Greek drama has gone from bad to worse. On June 30, Greece became the first developed nation to miss a debt payment to the International Monetary Fund. On the same day, a last-minute appeal by Greece for an extension of its second bailout failed as well, putting in jeopardy access to billions of euros in funding.
As the Greeks face increasingly dire circumstances, with banks and the stock market shuttered for a time and ATMs dispensing limited cash, a day of reckoning is coming. On July 5, the people will be asked to vote in a referendum whether or not they will accept creditors’ latest loan terms. An affirmative vote means staying in the eurozone; a “no” vote could hasten a Grexit.
While the eurozone was in turmoil over Greece, U.S. markets had a much more muted reaction. On the first two days of Greek bank closings, the Dow Jones Industrial Average, S&P 500 and the Nasdaq Composite fell by 1.8% each. Compare that to the Euro Stoxx 50 Index, which tracks the shares of eurozone companies; it fell by 11% over the same two days while the Global X FTSE Greece 20 ETF, which tracks Greek stocks, plunged by 19%.
U.S., German and U.K. bond prices did go up on the day Greek banks first closed, as investors fled to safer havens. But gold futures for August 2015 delivery are down. Overall, the 2015 response was more tepid than the rout in 2012, the last time fears arose about a Greek default and eurozone exit.
“Greece is a relatively small actor in the world financial system.” –Jack Guttentag
So what impact will the Greek debt crisis have on U.S. investors? “It’s not going to affect us very much,” says Jack Guttentag, Wharton emeritus professor of finance. “Greece is a relatively small actor in the world financial system. I don’t think anybody in the Federal Reserve is greatly worried about the ramifications of a default on us.”
Greece’s GDP is around $250 billion, similar to Connecticut or Louisiana and one-eighth that of California. Guttentag points out that the Greek crisis in the eurozone could be analogous to Puerto Rico’s possible debt default, which is not affecting the U.S. markets all that much.
“Greece is a really small country,” echoes Kent Smetters, Wharton professor of business economics and public policy. He adds that total foreign direct investment by U.S. investors in Greece is less than $2 billion. “Even if, very hypothetically, U.S. investors lost the entire foreign direct investment in Greece due to macroeconomic or political factors, the loss would be equivalent to the S&P 500 losing just 0.31 points.”
To be sure, Greece’s debt of 323 billion euros is no joke. However, “at most, 20% is held by actual private investors,” Smetters says. Most of the Greek debt today is not in private hands but instead held by the European Central Bank, International Monetary Fund and other eurozone countries, notably Germany. “But even if we count all of its debt, it makes up about a quarter of 1% of world debt markets,” Smetters adds.
The risk of contagion is also more limited today. European creditors and central bankers are more prepared now after experiencing the 2012 Greek debt crisis. Back then, ECB President Mario Draghi calmed investors by saying that the central bank would do “whatever it takes” to preserve the euro. “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,” says Wharton finance professor Jeremy Siegel. “As a result, it will be isolated to the Greek economy.”
Siegel adds that while the Fed will take into account any market concerns about Greece, he does not expect the crisis to be a “continued source of anxiety in the market.” As a result, he expects the Fed to raise the fed funds rate, or the overnight bank lending rate, in September, as markets generally have been anticipating.
Indeed, the first Fed rate hike in nine years should have a bigger impact on U.S. investors than Greece, Mark Andersen, head of regional asset allocation at UBS’s wealth management unit, told Bloomberg News in a June 16 story. Rising interest rates will lower bond prices and raise yields, as existing Treasuries lose value because newer debt will offer higher rates. Higher interest rates also lead banks to boost their prime rate, which affects the interest rates consumers pay on auto loans, credit cards and other borrowings. At least, it will boost savings and CD rates.
Greece’s Longer-term Effects
That is not to say Greece will not have any impact at all. “The Greek crisis has very significant implications for the U.S. economy, even if they are indirect and not seen immediately,” says Wharton finance professor Itay Goldstein. “The main reason for this assessment is that the Greek crisis will have implications for the eurozone, which is clearly important for the U.S. economy and for the U.S. financial markets. As things look now, it seems quite likely that Greece will end up leaving the euro. This will send a signal to the world economy that the euro is not as stable as was intended.
“The problems in Greece are structural, not cyclical.” –Kent Smetters
“While other countries in it seem to be in fair condition at the moment and not in any immediate danger of leaving, this might have implications for the stability of the euro going forward,” Goldstein adds. “That is, if Greece leaves, down the road when other countries get into trouble, investors might expect that they will drop [off] as well.” He points to international crises in the past that were caused by a domino effect across countries that do not have a direct, fundamental link, such as the Southeast Asian contagion in the late 1990s.
Moreover, the Greek crisis will persist for some time, even if its citizens vote to accept creditors’ latest terms in the referendum, notes Krista Schwarz, Wharton finance professor. “Greece will need more loans in the future, and these funds will be contingent on other adjustments,” she says. “The economic disruptions to Greece this year have ironically made their need for loans much bigger than before, and consequently the adjustments are much bigger.”
Schwarz points out that in 2010, Greece faced the choice between defaulting on its debt payments and leaving the euro or staying in the eurozone. “It’s not clear which would have been better for them. They chose to stick with the single currency and paid a high price for this,” she says.
For his part, Smetters says that he has been expecting Greece to default on its debt since 2009. “The problems in Greece are structural, not cyclical. There is no way that the Greeks would agree to the cuts that are required to achieve budget balance. There is no way that the international community will keep handing over money,” he adds. “Greece simply has to default.”
Thus far, the Greek crisis has had a limited effect on global markets, and Schwarz expects this will continue to be the case. “Greece is a small economy and the world has known about this problem for a long time,” she adds. “But contagion effects can be hard to predict.”