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Reporting From Europe: Impact of Likely Greek Default, Exit From Euro Zone

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This is the first in a series of blog postings from Europe at a critical time by peregrinating Ben Warwick, regular blogger for AdvisorOne and contributor to Investment Advisor. Ben is an investment advisor and author of the Searching for Alpha monthly newsletter.

LONDON—There is an old saying here that Americans don’t know where another country is located until the two go to war. Greece may become the exception to this rule.

Folks here and on the Continent are becoming increasingly convinced that Greece will eventually leave the euro. Austerity measures seem all but off the table at this juncture, as the fractured government that is forming in Greece seems to be leaning toward growth strategies as a more economically tenable solution.

This latter outcome would include Greek defaulting on its debts.

JPMorgan estimates the immediate costs to the eurozone at around 400 billion euros, or $510 billion, with the bulk of that loss coming from international bailout funds. Write-offs of commercial bank loans would be about 25 billion euros of the total.

This loss is being referred to as the “first order” effect of the Greek exit. The “second order” effects, which could be much larger in scope, would come from the perception that other indebted countries may become much more willing to follow in Greece’s footsteps.

I see this trade coming in two tranches. During the period of greatest uncertainty, sovereign debt will be the place to be. After the dust settles, traders will most likely prefer equities and corporate credit to lower-yielding government paper. At this point, we may witness lows in U.S. interest rates.

The outcome of the crisis in the E.U. is hardly set in stone, but a Cinderella ending seems far off in the horizon.


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