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Catching a Falling Financial Knife

Eurozone Debt Crisis "Day of Reckoning'

Interest-Rates / Eurozone Debt Crisis May 03, 2012 - 10:00 AM GMT

By: Money_Morning

Interest-Rates

Best Financial Markets Analysis ArticleDavid Zeiler writes: How many times have we been told the Eurozone debt crisis is resolved, only to have it turn up again like a bad penny?

Last year's string of good news/ bad news on the Eurozone debt crisis had the markets going up and down like a yo-yo until the routine grew so tiresome that most people stopped paying attention.


But while the crisis faded into the background, it never really went way.

Remedies that were sold as solutions haven't solved a thing.

The celebrated bailouts of countries like Portugal, Ireland, and especially Greece have served mainly to postpone real solutions that would be far more painful.

"The Eurozone politicians in their infinite wisdom have concluded that it is easier to prolong the agony than to take their medicine," said Money Morning Chief Investment strategist Keith Fitz-Gerald.

In fact, the Eurozone debt crisis is getting worse.

Collective debt among the 17 member nations is on the rise, having increased from 85.3% of GDP (gross domestic product) in 2010 to 87.2% last year. That's the highest level in the history of the Eurozone.

Unemployment in the Eurozone rose in March to 10.9%, up from 10.8% in February and 9.9% a year ago. Manufacturing also declined last month, as new orders fell for the 11th month in a row.

And the austerity imposed on the troubled PIIGS (Portugal, Ireland, Italy, Greece and Spain) to bring their budget deficits and debts under control have actually made the situation worse.

"It's done no good at all," Fitz-Gerald said of the Eurozone's efforts to deal with the debt crisis. "It's an absolute travesty."

The steep and sudden cuts in spending are pushing most of Europe back into a recession, which will eventually be felt here at home.

"The question is how long EU leaders will continue to pursue a deeply flawed strategy in the face of mounting evidence that this is leading us to social, economic and political disaster," Sony Kapoor, managing director of economic think-tank Re-Define, told the Associated Press.

A Eurozone debt crisis that climaxes in some sort of political or economic meltdown - which appears increasingly inevitable -will pinch the U.S. economy that much harder.

Eurozone Debt Crisis Spotlight Now On Spain and Italy
What's most disturbing about the recent news about the European debt crisis is that it centers on the much larger economies of Spain and Italy rather than the smaller economies of Greece, Portugal and Ireland --not that they don't still have problems.

Spain is the Eurozone's fourth-largest economy; Italy the third-largest. Bailing either out, even just to buy time, would not be easy.

In just the past week, Spain announced its unemployment is an alarming 24.4%. Unemployment among those under 25 is over 50%. Spain's economy contracted 0.3% in the first quarter and is projected to shrink 1.7% for the year.

Meanwhile, Standard & Poor's downgraded Spain's debt two notches. It was Spain's second downgrade this year, and places their rating three notches above junk status.

Italy's unemployment rate is over 9%, and is expected to reach nearly 10% this year. Italy expects its GDP to contract 1.2% this year.

Interest rates on the bonds for both countries have risen to uncomfortably high levels. Higher rates mean higher borrowing costs.

And as is the case with other PIIGS, Spanish and Italian banks have bought up much of that sovereign debt, increasing their risk of failure if the crisis reaches the default stage.

Just as ominous is the trend toward domestication of the debt.

"As the local bond markets have become owned only by domestic institutions, there is less and less incentive for the other countries to support and bail out one of those," Stephane Monier, head of fixed income and currencies at Lombard Odier Investment Managers, told Bloomberg News. "Basically you're planting the seeds for the disintegration of the euro zone."

Eurozone Debt Crisis "Day of Reckoning'
Although the game of prolonging the crisis by recycling the debt could go on for years, it just as likely could grind to a sudden, shattering halt.

"The day of reckoning is coming," Fitz-Gerald said. "At some point, the banks are going to say, "we're not doing this anymore,' or the nations will say, "we're not doing this anymore.'"

The strategy, Fitz-Gerald said, has been to stall the crisis long enough for economic growth to blossom and provide the money needed to climb out of the debt pit.

Of course, with austerity driving the Eurozone into recession, that plan clearly isn't going to work.

So the Eurozone is left with the same unworkable options it faced a year ago.

Troubled countries like Greece, Spain and Italy could be forced out of the Eurozone altogether, Fitz-Gerald said. Or the Eurozone could split into two -- the haves led by Germany, and the have-nots populated mostly by the PIIGS, though it's hard to see that working out well for anyone.

Governments could choose to end the euro, returning to their previous sovereign currencies. It would be a messy, expensive, and drawn-out affair, but over time would get Europe's economies back on the right track.

Or the Eurozone could start working toward a full fiscal union rather than just a monetary union.

That, however, would be politically difficult, as it would require all Eurozone nations to operate under a single unified budget. Many would balk at the loss of sovereignty, and Germany would end up even more responsible for cleaning up after the PIIGS.

"To adapt a classical allusion, the Europeans are between the Scylla of a currency breakup and the Charybdis of a federal union that nobody wants," financial historian and Harvard professor Niall Ferguson said on Bloomberg Television last fall. "And that's an extremely troubling situation to be in, because it means the economic solution is politically impossible."

With the Eurozone's political class unwilling to "take their medicine," it's becoming more and more likely that an unforeseen event will trigger a "Lehman moment" in the Eurozone debt crisis.

Which is why U.S. investors need to remain wary of Europe.

"The fundamental problems have not been resolved; indeed, the gap between creditor and debtor countries continues to widen," billionaire investor George Soros recently wrote in the Financial Times. "The crisis has entered what may be a less volatile but more lethal phase."

Source :http://moneymorning.com/2012/05/03/why-the-eurozone-debt-crisis-never-really-went-away/

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Catching a Falling Financial Knife