Kick the Can, or Kick-out Greece

Last week UBS released a report that attempted to estimate the costs associated with succession from the European Union. As there is really no mechanism to boot a country out of the EU, heavily indebted nations facing draconian austerity measures would presumably have to leave of their own volition. However, without bailouts from core-Europe and/or ECB buying of periphery debt in the secondary market, countries such as Greece would be forced to seek access to global credit markets on their own. They would be unable to do so at an interest rate they could reasonably afford to pay back, so it would be tantamount to an ejection from the union. They would be forced to secede and then massively devalue their currency.

There would likely be a collapse of the domestic banking system, and numerous corporate defaults on top of the sovereign default. According to UBS, the cost of a peripheral secession would be about €9,500 to €11,500 per person the first year, then €3,000 to €4,000 annually for some period afterward. With unemployment in Greece currently at 16%, and given the dire condition of the Greek economy, this is also a burden that Greece will be unable to bear. There are quite simply no good options here, but UBS seems to suggest that muddling along with the current reactionary patchwork of measures to save Greece is the lesser of two very large evils. This pretty much assures that Greece will be mired in slow growth and high unemployment for years, if not decades to come.

What makes the current situation different than previous iterations of the Greek crisis is last week’s ruling by the German constitutional court. While the court upheld the legality of the EFSF rescue measures — to the great relief of the markets — but, as the FT’s Wolfgang Munchau pointed out, the ruling “categorically rules out any policy option beyond what has been agreed so far.” The court effectively has rendered impossible the two measures that most likely could save Greece and other periphery nations; a permanent bailout facility and/or eurobonds. Even if European policymakers were to embark on the long and painful path to change the treaties governing the EU, there is little hope that Greece can be saved, and perhaps that’s true of all the PIIGS.

Suddenly Germany, which has been the source of all manner of reassurances over the past 16-months, is putting together a contingency plan to protect their banking system if — or perhaps now it’s ‘when’ — Greece defaults. Lars Feld, an economic adviser to German Chancellor Merkel, acknowledged today that an orderly restructuring of Greek debt is indeed being discussed. Feld however warned that “they must also be prepared for an unorderly restructuring that could take place as well.”

The euro has fallen to 7-month lows against the dollar. European stocks have tumbled to levels not seen since the summer of 2009.

Anyone who believes that the turmoil will be contained to Greece — or even that side of the pond — does so at their own financial peril. Germany, who is arguably as well connected to the situation as a country could be, is putting their contingency plan together. So should you.

Finally, the UBS piece ominously reminds us that “almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.”