We Haven’t Shaken “The Greece Effect”

08/05/2011 11:30 am EST

Focus: GLOBAL

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

There are two ways to look at the Greek debt debacle—as isolated incident and as metaphor. The latter view is still having its effects on the global markets today, write Mary Anne and Pamela Aden of The Aden Forecast.

It was an intense month for the currency markets. They were nervous, jittery and volatile. Boiling it all down, there were two reasons why… Greece and the slowing world economy.

Greece: Center Stage
As you all know, the Greek drama took center stage, and it affected most of the markets. That’s been the case for a while now. But it intensified so much in June and July that most currencies were rattled.

The big question was, would Greece default on its debt or not? Despite behind-the-scenes efforts to avoid this outcome, and public statements from top Eurozone and international officials including Obama, Merkel, and Sarkozy, when it looked like Greece might default, the currencies fell.

On the other hand, the US dollar rose, benefiting as a safe haven. It was the place to go to avoid the possible fallout from what was happening in the Eurozone.

Many wondered, what’s the big deal about Greece? Who cares if they default, and why is everyone so fixated on this relatively small country?

What no one was saying outright was that fears of 2008 were again becoming all too real. They were looming overhead because Greece was capable of triggering another 2008 snowball effect. How?

The Domino Effect
First, a default by Greece would have disrupted most markets worldwide, probably fueling panic. Remember, contagion is still alive and well, and with the global markets more connected to each other than ever before, this would have likely happened rather quickly.

It would have surely affected the other marginal Eurozone countries, who have been skating on thin ice, speeding up their downfall.

Portugal’s debt was downgraded to junk in July, and the situation remains very vulnerable. Any upset could threaten the existence of the entire Euro 27 country community as we know it today, and the euro.

Then there’s the banks. Many of the Euro banks are up to here in Greek debt, holding about 70% of this debt. US banks are exposed too. Any threats to the Eurozone’s stability would have hurt banks globally. Think of Lehman Brothers and the domino effect in 2008… this would have been similar, if not worse.

And the crisis wouldn’t have just stayed in Europe. The US, China, Russia, and most other countries are holding Eurozone bonds (debt). In fact, many of the largest US money-market funds have a big chunk invested in Euro banks or debt, something like 40%.

So clearly this would have become a global crisis, probably triggering a recession. That’s why everyone was worried about Greece, as the currencies reflected.

But as violent riots gripped Athens in protest against austerity measures, many wondered if the government would actually go through with the spending cuts, in order to obtain more funds to avoid going bankrupt.

In the end, they did. The Greek people are unhappy but the government did what it had to do. It was in a corner and there was no way out.

NEXT: US Dollar Bottoming?

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US Dollar Bottoming?
This too has provided a boost for the US dollar. Again, a slowing global economy makes the dollar more attractive because it’s viewed as a safer option compared to other countries.

For now, it still looks like the US dollar is bottoming and currencies are topping. Even though the major trends remain up for the currencies and down for the dollar, a temporary rebound will probably unfold in the months ahead.

This scenario will be reinforced if the US dollar index holds above its record low at 71.50. If it doesn’t, then all bets are off and we’ll buy more currencies. But we’d be surprised if that happens.

Of course, anything is possible, and we have to stay open to all possibilities. Looking at the Japanese yen, for instance, you can see that it’s risen far in recent years. But it looks to be topping, similar to what happened in the mid–1990s, prior to a steep fall.

Will history repeat? It could…and if it does, the other currencies will likely fall too as the dollar strengthens. If so, it would mean trouble ahead. But again, we’ll stay flexible.

Currently, we’re keeping our currency position, diversified between US dollars and the Swiss franc, which has held firm during this tension period, as well as the Canadian dollar. But other strong currencies, like the Australian dollar, are still fine to keep too.

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