New Greek Government Could Bring Down The EU and Cause Havoc for Investors

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Last Updated on: 6th February 2015, 04:31 pm

The European Union is facing its most challenging test to date thanks to a recent election in Greece. The new Greek government came into power on a platform challenging austerity and the current terms of Greek debt to creditors. This is setting up a major showdown because the heads of the EU don’t seem willing to make any changes. Unless one of the two sides makes a significant policy adjustment in the next few months, it could have serious consequences for the EU and investors around the World.

Overview of the Greek political situation

Since the start of the financial crisis, Greece has been struggling. The country had too much debt before the crisis started and when the economy tanked, the situation got even worse. To keep the government running, Greece had to take out a series of loans from the troika, a group of creditors made up of the European Central Bank, the European Commission, and the International Money Fund.

One of the provisions of these loans was that the Greek government would raise taxes and cut spending so that it would start running a budget surplus to pay off the debt. Over the past few years, the Greek government, led by the conservative New Democracy party, was able to make headway and started running a surplus. However, this came at the expense of the economy. Greece has been struggling with soaring unemployment for years and the unemployment rate is currently at 25.5%. The Greeks finally had enough and in last week’s election, voted for the left-wing Syriza party in a landslide.

The battle between Greece and Germany

Syriza’s platform is radically different than the previous government. Syriza is anti-austerity and would like to charge the terms of Greek’s outstanding debt so the government can reduce its payments. This would give the Greek government more room to spend and lower taxes. Ideally, Syriza would like to renegotiate the outstanding debt to a smaller amount. Currently, Greece owes about 240 billion Euros, which represents 175% of its annual GDP.

It’s one thing for Syriza to propose these new conditions. It’s a whole different story whether the rest of the EU will go along. Greece’s creditors have expressed that they have no interest in writing off any debt, though they did say they could restructure. Germany in particular seems uninterested in making any changes which puts Greece in a tough position.

Debt crisis looming

The lack of agreement is scary because Greece is on the verge of a crisis. Basically, the government is almost out of money. Since Greece doesn’t have its own currency, it can only finance spending through its revenues or from loans. Greece is currently running off a short-term loan from the troika. Analysts expected that this money would’ve lasted until mid-year but the new election has made the situation more pressing.

Fearing instability and a possible withdrawal from the Euro, Greek citizens have started taking money out of banks and stopped paying their taxes. As a result, the Greek government could run out of money by the end of February.

How problems could spread

While the situation is very severe in Greece, Greece is just a small part of the EU and an even smaller part of the World economy. What’s really scary about this situation is if political trouble starts spreading to other countries. Europeans are sick of austerity and high unemployment which is pushing them to consider radical policies.

In Spain, the anti-austerity Podemos party is currently leading in polls while the Italian government is also facing challenges. If Greek ends up abandoning the Euro and defaulting on its debt, there will be pressure on other governments to consider the same thing especially if Greek’s economy starts to recover right after. This could potentially mark the end of the Euro and would create a major shock to the World economy.

Impact for investors

So far, the market impact of the Greek election has been pretty muted. Markets have held steady as investors seem confident that Greece and the EU will come to some sort of agreement. The Dow has completely rebounded from the 3% loss it took immediately after the election.

The Athens Stock Exchange also bounced right back.

It’s hard to share this optimism though considering the rhetoric coming from both sides. Syriza come into power promising significant changes whereas German leaders are committed to keeping things the same. A meeting between Greek and German officials last week failed to produce any results.

If Greek defaults on its debt and leaves the Euro, it’s going to be sudden and the market impact will be pretty devastating. Investors will likely panic especially as they worry about other countries defaulting on their debt. European markets will take the biggest hit but it’s hard to see how America comes out safely since the American recovery is pretty fragile.

Investors should consider some sort of hedge against market instability. Gold is a good choice given its strong run during the past financial crisis. It could also be a good time to start moving out of stocks in anticipation of a sudden downturn in the next few months.

Hopefully, Europe is able to come to some sort of agreement and maintain the Euro. However, investors should prepare for the worst and start planning on how they can protect their savings in the event of a collapse of the European Union.