Economic News & Analysis—June 18, 2012

Greece: From the heart to the heartburn of Europe

By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist, and John Manley, CFA, Chief Equity Strategist

On May 6, Greek citizens elected a fractured government. Because the government was too fractured to form a functioning coalition, they were forced to give it a second try. On June 17, they may have elected another fractured government, but at least it’s one that can probably function. New Democracy (the center-right party) finished with the most votes, followed by Syriza (the communist party) in second, and Pasok (the center-left party) in third.

Greece has a reinforced proportional representative system of parliament with 300 total seats, meaning representation in parliament is proportional to the votes received. It is “reinforced” in the sense that whichever party gets the most votes captures an additional 50 seats. Parliament must then elect a prime minister, which requires at least 151 votes. Failure to elect a prime minister means Greece does not have a functioning government.

After the most recent election, New Democracy will control 129 seats, Syriza will have 71 seats, Pasok will have 33 seats, and the Democratic Left party will have 20 seats. Because no single party has at least 151 seats, they will need to negotiate to form a coalition government. If New Democracy is able to partner with Pasok, they could elect a prime minister and form a government. After the May 6 election, New Democracy and Pasok pulled up just short of forming a government.

Syriza has already indicated it will not go along with New Democracy, so the ball is in Pasok’s court—for now. As of this writing, it is unclear whether Pasok will agree to form a government with New Democracy. In game theory, we would call this a classic “hold-out problem.” Pasok is dwindling in significance after years of being in the vanguard of Greek politics and is now trying to maintain its relevancy. It is still possible, though, that a government could be formed without Syriza or Pasok. Getting New Democracy and Pasok together looked like the path of least resistance to forming a government, but because Syriza and Pasok only control 105 seats, they don’t represent a “blocking coalition.” In other words, while the minority parties can slow things down, the president of Greece, Karolos Papoulias, will have to exercise all his diplomatic skills to cobble together a government out of these squabbling factions.

I think he’ll be successful. Yesterday’s French legislative elections delivered the Socialist Party a solid majority in the French parliament. Given that the French Socialist Party has been sympathetic to easing some of the onerous requirements placed on Greece, President Papoulias could plausibly persuade the Greek parties that they have allies in the eurozone, not enemies. Further, German officials have openly discussed extending the time frame over which Greek austerity measures need to be implemented. In order to ease the pain, all Greece needs to do is form a functioning government.

In 2001, when Greece was invited to join the eurozone, the Greek finance minister said that joining the eurozone would put Greece at the heart of Europe. Now, 10 years after officially dropping the drachma and adopting the euro, Greece is more like the heartburn of Europe. Regardless, I believe that Greece will ultimately retain the euro and remain a member of the eurozone. Even if the new government in Greece is short-lived, it will at least serve as a bit of an antacid to the euro problem.

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