Ελλάδα Role in the Economic Domino Theory.

I am going to make a prediction: Greece will default unless they see a large portion of their debt forgiven outright. Shocking, right?

Here’s the simple story about Greece:

- They are very unfriendly towards business -- getting one started, keeping it open, the whole nine yards.

- The underground economy is massive (30%) because of the huge taxes they have there (VAT alone is 19+%) making it impossible to collect tax revenues accurately.

- Even if they could collect tax revenues accurately, they don't have the economic firepower to pull themselves out of their debt disaster, especially with an elevated euro.

- Fifty percent of GDP is government spending.

- Entitlements dwarf the current debt, making their situation all the more impossible.

I can hear the rebuttals now --“But Greece is only 2% of the Eurozone economy.”

True.., but let’s look at how that impacts the rest of the Eurozone.

1. Greece is a major importer of German goods.

2. Sixty percent of Greek debt issued in the last few years was bought by other European countries leading to massive mark downs if Greece defaults (mostly the French €73B, Swiss €59B, and Germans €39B; that is 3% of France’s GDP).

3. Fifty-one percent of Portuguese debt is owned by Spanish banks.

4. Thirty-two percent and 25% of Spanish debt is held by German and French banks respectively.

Can you say "economic domino theory"? Write-downs from losses in sovereign debt default will be a big negative for other countries, and investors will aim for Portugal and Spain (they already are if you look at Portugal’s CDSs) as the next stop for the default train.

Right now there are two prevailing scenarios:

1. Greece leaves the euro.

2. Germany leaves the euro.

Greece leaving the euro would actually mean a stronger euro, but it’s also possible that Portugal and Spain follow suit and cause real problems for the currency. Removing multiple Eurozone countries defeats the purpose of a common currency, so they might as well just go back to a free trade zone. On the surface, that doesn’t seem like the answer.

A German departure is much more interesting to me, and the more I look into it, the more I think this may be the best option if the currency is to survive. The Germans may be moving in this direction as well.

The Germans are the only adults in Europe and the people there have been quite loud about their dislike of bailing out the imprudent. If Germany leaves, they're likely to see lower interest rates and, of course, will have total control over their currency. This will leave the rest of Europe to toil with a weaker, less stable euro. But believe it or not, this isn't a bad thing. Many of the remaining nations are highly dependent on tourism as a major piece of their economy (this is especially true in Greece) and a cheaper currency makes it much easier for foreigners to take trips. (The big fix will have to come by creating a common tax system, but that appears to be far too complex with too many stepped-on toes to actually come to fruition.) Also, a weaker euro for Greece (and probably Spain and Portugal), even below parity with the dollar, is far preferable than a return to the drachma which would undoubtedly see a massive devaluation, possibly into the 500-600 drachs per dollar range. It was roughly 350 when Greece entered the euro in 2001. That would be devastating to the people of Greece.

I'll just keep an eye on the EUROs for now.