Markets have been driven down this year on fears of a Greek exit from the Euro, but two quick questions: would it really be so bad? And what would the likely outcome be of a Greek reversion to the drachma?
The euro has not suffered as badly from the debt crisis as the landslide of media coverage would suggest. As a Financial Times article points out, before the Greek elections at the start of May, the euro had barely moved against the dollar for most of the year and yet speculation had been rife about any number of Armageddon scenarios that could engulf the Eurozone.
Since then, the euro has hit a 22-month low as of last week, dropping to $1.2514 against the dollar and a loss of 5 percent on the month, a substantial move for any currency and 22 percent below its all-time high of $1.6038 in the summer of 2008.
Citibank is putting the chances of a Greek exit at 75%, and the range of predictions as to where the rate could end up depends on the “stay-in” option or the “stay-out.” The average of 58 predictions given by analysts in Bloomberg is $1.28 by the end of the year, with the most bearish in the range coming in at $1.15, an 8% fall from current levels. But these estimates are on the whole assuming a stay-in result.
Citi estimates that if Greece leaves and an effective firewall is not established (recent history suggests the Europeans are incapable or unwilling to fund effective support), the euro could drop to $1.01. However, if next month’s elections were to return a pro-austerity government (as recent polls have suggested is looking a little more likely), the euro could bounce to $1.30 – fancy planning your currency hedging in that environment!
One reason the euro has held up so well is that those wishing to diversify currency holdings don’t have too many other places to go. The FT advises that the euro is the second-most liquid currency in the world after the US dollar, accounting for nearly 40 percent of all daily trades, according to the most recent figures from the Bank for International Settlements.
Continued in Part Two.