by Jason Jenkins, Investment U Research
Friday, December 16, 2011
The expression is called “kicking the can down the road.”
And it’s a practice that the Eurozone and European Union have gained an expertise in demonstrating…
After meeting all night in Brussels last Friday, European Union leaders agreed to a new fiscal compact.
They also brought forth stabilization measures to aid the inept structure of the Eurozone. The deal immediately received mixed reviews from all over the world. U.S. stocks rose sharply, but European sovereign debt saw no relief.
Then, on Monday, after further scrutiny, the market adjusted as it saw that what the pact agreed upon was a solution for down the road.
However, the true crisis is now.
The Possibility of Default Rears its Ugly Head
Austerity measures are all well and good, but there are many countries in the Eurozone – most notably the PIIGS – whose immediate crisis is the fear of default by the end of 2012.
Simply stated, these nations’ debt-to-GDP ratios have become so unsustainable that the market doesn’t think it will get their money back if they buy their sovereign debt.
Why? There’s no economic growth…
“The fundamental problem in the most troubled European countries is that the debt burden is growing at a faster rate than their economies are,” said Michael Cheah, who manages a $1-billion fixed income fund at SunAmerica Asset Management in Jersey City, New Jersey. “That’s been the problem for a long time. Yet the only solution we get is more discipline, more austerity.”
Let’s take Italy’s government, for example. It recently took Greece’s position as the Eurozone’s new whipping boy. The Italian government submitted a €30-billion package of spending cuts and tax hikes last week, but its economy is forecasted to shrink by 0.5 percent for 2011 and post zero growth for the next couple of years.
Markets are losing faith in the economic viability of countries and soon will see the risk as too high to continue lending. This is the reason sovereign debt has reached unsustainable levels with the PIIGS – with some already receiving direct bailouts.
These direct and indirect bailouts have made the debt bubble bigger, bringing forth a strong possibility that these unsustainable levels of borrowing will force countries to leave the Eurozone.
What About the Short Term?
Depending on your school of economics, you may agree or disagree with the following courses of action. However, they’re all viable policies to address the short-term crisis:
- Shared debt issuance
- Move to an EU Treasury
- Banking license for the ESM rescue fund
- Change in the mandate of the European Central Bank
The pact did create a new €500-billion bailout fund, called the European Stability Mechanism, that will replace the European Financial Stability Facility and European Financial Stabilization Mechanism.
But, as I’ve written in the past, unless a bailout fund gets into the multi-trillion euro neighborhood, it will not save any country.
How Will it Play Out?
The new fiscal pact has allowed a short-term crisis to be a catalyst for a long-term solution, which will break down national sovereignty impasses and impose a more centralized structure. That’s a good thing. What’s even better is that this default crisis will probably end up changing the makeup of the Eurozone by the end of next year – a stronger zone with Germany as its backbone.
Europe will not totally blow up, so this might be a time to buy into the market using actual valuations and ignoring headline risk.