Saying that Greece caused the euro crisis is like saying that Lehman Brothers caused the financial crisis of 2008. The truth is that neither were causes, but both were (rather potent) catalysts of their respective financial imbroglios.
Lehman was the victim of total U.S. financial system leverage, which had been rising for 25 years and peaked at 385.7% in the first quarter of 2009; total financial leverage in the system has been coming down ever since, to the present 354.7%. Leveraged balance sheets at the banking, overall corporate, governmental and consumer level sooner or later tend to result in leveraged debt liquidation, which Lehman notably accelerated with its unfortunate failure.
Greece accounts for only 2.65% of eurozone GDP, but the rounding-error status of the dirtiest of the PIIGS is not what is relevant here. It is the precedent for leaving the monetary union that is the issue, as Italy and Spain both comprise 17% and 11.7% of eurozone GDP and taken together are bigger than the strongest eurozone economy Germany (26.7%). Suffice to say that if either Spain or Italy or both leave(s) the euro, the common currency is unlikely to survive.
When I wrote “The Euro is in Trouble” on March 12, 2009, there was no Greek default and PIIGS had not yet become a well-known term. But precisely the conditions that prompted me to write this missive have brought the present crisis, and I am sorry to report that none have been addressed.
The euro was designed with a potentially lethal flaw, where 17 different divergent fiscal policies — sometimes in direct contraction with the spirit of the monetary union — were accompanied by a single monetary policy. The acceptance of formerly weak-currency PIIGS countries in the monetary union initially caused their domestic interest rates to drop, fueling asset bubbles whose unraveling is causing serious strain on their financial systems at present. Lower interest rates induced unsustainable government borrowing that also added to the problem that grew over a decade of common currency.
Ironically, it was the the unwinding of financial-system leverage in the U.S. catalyzed by the Lehman failure that set off the necessary ripples to start this eurozone crisis.
What are the odds of the euro falling apart? For that, we look at the sovereign bond markets, which have been signaling increasing likelihood by the day. Two-year German government bond yields are at 0% — yes, zero percent — while the same maturities in Italy and Spain yield 4.1% and 4.85%.
But it is not the absolute level of interest rates that signals rising stress in Europe. The interest rate differential between German bunds and Spanish 10-year bonds is reaching all-time highs, and the one with Italian bonds is rising again. Investors would rather lend money to the German treasury for free to avoid the risk of taking an immediate currency discount in historically weakish southern European currencies in the event of euro secession by either Spain or Italy.
What is more extreme, investors would rather pay the Swiss treasury 0.29% per year for two years to hold their money for them to avoid the currency risk. The temporary stabilization brought on by the deployment of 1% LTRO funds did absolutely nothing to resolve the European situation.
The Greek election on June 17 certainly is a big focal point where anti-bailout parties better not get majority in parliament, as this would raise the odds of the ultimate euro secession domino effect. The rising stress in the Spanish banking sector where a run of unstable banks is ongoing is another issue to keep on your radar.