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Three reasons Greece still matters

China's state-defying market meltdown and the New York Stock Exchange's shutdown seized investors' attention this week, and rightfully so.

But Greece still matters to the markets, despite a growing consensus that it's 'too small to matter' and the 'firewall' built between it and the rest of Europe is sufficient to contain the damage.

Here are three reasons why Greece still matters:

Known Unknowns:

Greece leaving the eurozone, aka a Grexit, is much closer to reality today versus a week ago, when most pollsters and pundits thought Greek voters would vote 'yes' on Sunday's referendum.

The 'no' vote and Greece showing up empty handed at Tuesday's "emergency" meeting have greatly raised the stakes for Greece, and the odds of a Grexit.

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“We are changing our view and now believe that Grexit – Greece’s exit from the eurozone – is the most likely outcome,” Citigroup wrote in a July 8 research note.

Other Wall Street players have come to a similar conclusion.

More importantly, “we have a Grexit scenario, prepared in detail,” European Commission President Jean-Claude Juncker told reporters on Wednesday. "The commission is prepared for everything."

Raise your hand if you think that's true. 

Should it occur, a Grexit is a Grey Swan event, to borrow from Nassim Taleb: We can see it coming but nobody really knows what the outcome will be.

Just as no one predicted Lehman Brothers' bankruptcy would cause the Primary Fund to 'break the buck', it's nearly impossible for policymakers and traders to predict with any confidence what the financial market fallout will be as Greece would be the first country to ever leave the euro.

"How many times have we heard 'we can contain it'?," Barry Habib, CEO of MBS Highway asks rhetorically.

"It's always 'we can contain it' but you can't bet on that. It's very difficult to handicap whether it will be contained."

Among others, Habib expects a Grexit would accelerate flows into so-called safe-haven trades like German bunds and U.S. Treasuries, predicting the 10-year yield (^TNX) could fall below 2 per cent.

"If Greece walks away you change your thinking about bonds in countries that are maybe going down the same road," he said, citing Spain as the primary example.

"You're not going to be crazy about investing in Spanish sovereign bonds, [so] debt costs wind up going up, which exacerbates their problems."

Yields on the debts of Spain, Italy and Portugal haven't moved much since Sunday's referendum, a sign investors either don't believe Greece will leave the euro, or that it can be contained.

One outcome of a Grexit is that a precedent for leaving the euro will be set, potentially leading to permanent destabilisation of the currency and the trading block, according to Martin Wolf.

"A big question, in sum, is whether the members of the currency union should want exit risk to be a core part of the eurozone’s construction," writes the Financial Times' chief markets commentator. "I think they should not because such a eurozone would be frighteningly fragile."

A 'frighteningly fragile' currency bloc doesn't sound like a non- or even minor event, does it? 

"I have no doubt that this is the most critical moment in the history of the European Union," Donald Tusk, head of the European Council, said Tuesday, dismissing the idea a Grexit would be a minor event or even a positive development for both Greece and the EU, as some suggest. "If someone has any illusion that it will not be so, they are naive."

Tusk also said that Sunday's deadline for Greece to reach a deal with its creditors is truly "the final deadline." But if the U.S. can continually extend talks with Iran over nuclear weapons, I can't imagine the EU wouldn't extend talks with Greece until at least July 20, when a 3.5 billion euro (about $3.8 billion) payment is due.

Whatever the real "final" deadline for Greece turns out to be, the question for traders is whether to bet on Juncker's stoicism or Tusk's lament. Financial markets have shuddered in recent days but are still priced for either a last-minute deal for Greece to stay in the eurozone or for it to be a relatively 'contained' event.

Of course, with risks come opportunities. David Kotok, CIO of Cumberland Advisors which has $2.4 billion of assets under management, is "very bullish" on European equities based on a belief the European Central Bank will unleash another round of quantitative easing as a result of the Greek drama, Grexit or not.

"Europe is now looking at zero interest rate policy (ZIRP) for the rest of the decade," Kotok says. "We are confronting a world where 25% of reserves are denominated in ZIRP currency."

 

Economics:

Those tallying the debts owed to various creditors in assessing the potential impact of a Grexit are missing the forest for the trees.

Indeed, Germany has much more to lose than the roughly $61 billion it is owed by Greece as it is arguably the prime beneficiary of the eurozone.

At about 2 per cent of the Eurozone, the Greek economy may be small but its departure from the euro could have a large impact on the global economy, particularly if the euro weakens further versus the dollar.

"Many (FOMC members) expressed concern that a failure of Greece and its official creditors to resolve their differences could result in disruptions in financial markets in the euro area, with possible spillover effects on the United States," the minutes of the Fed's June meeting revealed.

Further dollar strength poses a “prominent risk” to the global economy and could leave U.S. growth “significantly debilitated”, the IMF warned this week, prior to cutting its global growth forecast.

“Disruptive asset price shifts and a further increase in financial market volatility remain an important downside risk” to global growth, the fund said on Thursday.

 

Geopolitics:

The 'no' vote in Greece's referendum has been cheered by far-left parties in Italy and Spain, and far-right parties in Germany and France.

The same anti-austerity, anti-Troika sentiment that brought Syriza to power in Greece exists to varying degrees in other European countries.

Should a Grexit lead to market upheaval and broad economic pain in the eurozone, other so-called moderate and center-left  governments in the European Union could fall.

Political upheaval could lead to greater geopolitical stress in Europe.

The Russian economy has been hobbled by Western sanctions and oil's slump but Vladimir Putin's regime still has plenty of firepower, literal and figurative, at its disposal.

"If Greece does leave the eurozone, the economic aftershocks to the domestic economy could reduce it to a semi-failed state that, along with the dismemberment and weakening of Ukraine, will seriously weaken Europe’s geopolitical position vis-à-vis Russia," Robert Kaplan, a senior fellow at the Center for a New American Security, recently wrote in The WSJ.

id="yui_3_18_1_1_1436490702916_2299">If this happens not only will the Iberian states of Spain and Portugal be more susceptible to euro-debt contagion, but Balkan states with weak institutions and fragile economies like Albania, Bulgaria and Romania will be in a more exposed position. While those states were never part of the eurozone, the spectacle of a major Balkan country pivotally loosening its ties with the West, even as Russia appears momentarily ascendant in the region, will be sobering in the extreme.

Sobering? Yes. Extreme? Let's hope so. 

Aaron Task is Editor-at-Large of Yahoo Finance. You can follow him on Twitter at @aarontask or email him at atask@yahoo-inc.com.