Former Chief Executive Officer of Pacific Investment Management Co. (Pimco) Mohamed El-Erian predicts there is an 85% chance that Greece will leave the eurozone within the next few weeks. This would possibly spark a period of extreme market volatility. (Source: Bloomberg, June 29, 2015.)
On Sunday night, Greek Prime Minister Alexis Tsipras announced that Greek banks would be closed, imposing a daily withdrawal limit of 60 euros on bank machines. The Greek banks are not expected to reopen until after a national referendum on July 5th.
The decision to close down banks was made after the European Central Bank’s (ECB) announcement that it would not provide further emergency loans to Greece. The Greek government feared that funds would run dry soon and shut down the banks.
El-Erian thinks that Tsipras was facing a lose-lose situation and decided to go to the people for opinion. The former Pimco CEO also mentions that shutting down banks would create some “very dangerous and difficult days” for the country.
“What we are seeing here is what economists call the sudden stop, when the payment system stops,” says El-Erian. “The logic of a sudden stop is a massive economic contraction, social unrest and it’s going to make continued membership of the eurozone very difficult for Greece.”
Indeed, a halt in the banking system can be catastrophic for the economy. When the payment system stops, people do not have enough cash for daily transactions. Businesses cannot pay their suppliers. Pensioners cannot get paid.
“If you were to put a gun to my head and say give me your probability right now that Greece is in the eurozone in the next few weeks I will tell you it’s about 15%. There is an 85% probability that Greece will be forced to leave the eurozone, not because it wants to do so but because it simply is not able to stay.”
According to El-Erian, the impact of the potential “Grexit” can be transmitted through three channels. The first one is economic. But since Greece contributes a mere two percent to the eurozone’s total output, the economic impact is not going to be substantial.
The second channel is financial. Since today’s financial system is highly interconnected, uncertainty will increase around the “Grexit.”
The third channel is a technical one. Greece will lead to “de-risking” activity. Investors will move towards safer assets as opposed to risky ones, meaning prices of risky assets (such as stocks) will go down.