European Debt Is a Global Problem

What price unity? Eurozone leaders might finally find out. Italy is in crisis, and Greece is likely past the point of no return. In the past year and a half, the eurozone has already approved bailouts for Greece, Ireland, and Portugal. Italy hasn't yet come to the European Central Bank's door with hat in hand, but it's already passed a fiscal tipping point, and its debt load might be enough to break the euro's back.

Uncertainty has a long and well-chronicled past on the European continent. Crises never happen in quite the same way, but they sometimes have certain poetic similarities.

The widening gyre
Bailouts for other eurozone nations came shortly after the 10-year bond yields of troubled nations rose past 7%. Italy remained of lesser importance because its yield remained under 5% until quite recently. However, savvy bond traders could have told you back in mid-August that things were starting to heat up. The threshold was crossed yesterday, sending investors running for the exits. The Dow (INDEX: ^DJI  ) is coming closer to losing a month of gains as it waits for another shoe to drop.

Country

Current Bond Yield

Yield Passed 7%

Bailout Approved

Greece 27.8% 4/06/2010 5/2/2010*
Ireland 8.2% 11/01/2010 11/28/2010
Portugal 11.6% 1/18/2011 5/17/2011
Italy 7.2% 11/09/2011 N/A

Source: Bloomberg and news reports.
*Eurozone leaders agreed to a second bailout on 7/22/2011.

The center cannot hold
But the response of EU leaders is different this time. After hammering out two separate Greek bailouts, and after engineering the rescue of Ireland and Portugal, France and Germany are now speaking of breaking apart the eurozone as Italy's government runs headfirst into a wall. The European Financial Stability Facility -- or EFSF -- the eurozone's current backstop against default, is woefully unable to support an Italian bailout. Italy's debt load is a Pompeian explosion compared to the tremors of three peripheral eurozone nations, and discharging it could be as difficult as stopping an active volcano.

Country

GDP

Debt

Bailout as % of Debt

Greece $305 million $436 billion 74%
Ireland $204 billion $196 billion 46%
Portugal $229 billion $213 billion 52%
Italy $2,051 billion $2,441 billion N/A

Source: Trading Economics and author's calculations.

Meanwhile, Greece dithers, Ireland is getting used to the pain, and German chancellor Angela Merkel calls for tighter political union as rumors swirl about two-speed Europe becoming two-part Europe. Her latest response to the crisis has a certain uneasy familiarity to students of history: "It is time for a breakthrough to a new Europe. Because the world is changing so much, we must be prepared to answer the challenges. That will mean more Europe, not less Europe." The end result could be a stronger central bank, the ouster of debt-ridden countries, a unified government, or any combination of several alternatives, none of them pleasant in the near term.

What rough beast, its hour come round at last...
At its current capitalization, the EFSF has the power to lighten burdens to the tune of $595 billion. Proposed additions might push that amount to $1.45 trillion, barely enough to cover an Italian bailout on the same scale as those offered to Greece, Ireland, and Portugal.

But who can bail out the rescuers? Italy is on the hook for 18% of the EFSF's current capitalization requirements, or $79 billion. That's near the cost of the entire Irish bailout, and a heavy cost for a nation whose economy moved at a glacial pace over the past year.

It's hardly the only eurozone country moving at a crawl. Germany's GDP has flattened, as have France's, Belgium's, and the Netherlands'. French bond yields are quickly moving higher than those of German bonds, an alarming sign that even the strongest European economies are viewed with increased skepticism. French banks hold more Greek and Italian debt than other eurozone nations by a wide margin. And the U.K. and the U.S. hold more French debt than any other nations.

A slowdown looms over many multinational companies with major European operations, including Philip Morris International (NYSE: PM  ) , Ford (NYSE: F  ) , and McDonald's (NYSE: MCD  ) , but the potential for global recession leaves very few risk-free. The Chinese rely on Europeans to buy their exports.

...slouches toward Bethlehem to be born?
No easy solution lies ahead for Europe. Implementing a single, unified government -- as many have proposed -- would be a politically chaotic and protracted affair, and its costs would likely dwarf the $1.9 trillion it cost to rebuild a reunified Germany. Removing heavily indebted nations from the eurozone would almost certainly result in recession throughout Europe and the rest of the world. Staying the course is untenable, but there isn't enough money left to take the easy way out. At some point the bailouts will have to stop.

Will the world learn its lessons this time around? Can it afford not to?

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Fool contributor Alex Planes holds no stake in any company mentioned here. Add him on Google+ or follow him on Twitter for more insights and random information. The Motley Fool owns shares of Ford Motor and Philip Morris Intl. Motley Fool newsletter services have recommended buying shares of Philip Morris Intl, Ford Motor, and McDonald's. 

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Read/Post Comments (13) | Recommend This Article (28)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 10, 2011, at 4:48 PM, Darwood11 wrote:

    "For those worried about a new financial crisis..."

    No, I'll pass. I'm quite enthralled by the current one!

  • Report this Comment On November 10, 2011, at 5:28 PM, xetn wrote:

    I believe this is the end-game for the Euro and the EU. Some or all of the PIIGS will default (Greece's interest on their debt is running over 100% and no one can sustain that level, even if the ECB convinces the big banks to take a 50% haircut.) So, Greece will default sooner or later, probably sooner. Once one defaults, the others will be close behind.

    The EU is already creating a new "mechanism" called the ESM (EUROPEAN STABILITY MECHANISM) which will endeavor to create a new version of the IMF and require all EU countries to pony up billions of dollars and be exempt from any legal issues. It too, will probably fail because they will continue trying to inflate themselves out of the crisis. Same song and dance. This is all to save the largest EU banks. The citizens be damned.

  • Report this Comment On November 10, 2011, at 6:52 PM, lollard wrote:

    Suggested alternative title: The Valley of the Black PIIGS.

    I'm sure appropriate quotes could be pulled from Euripides, Dante, Cervantes, and the Lusiads to round things out....

  • Report this Comment On November 10, 2011, at 7:05 PM, lollard wrote:
  • Report this Comment On November 10, 2011, at 7:32 PM, kantcould wrote:

    Alex Planes' quote from W.B.Yeats is a nice scholarly touch to characterize a reckoning perhaps as tectonic as the "second coming". We can watch bemusedly at the slow unraveling of the EU but the same "tide that lifts all boats" may become the tsunami that swamps all yachts.

  • Report this Comment On November 10, 2011, at 8:03 PM, midnightmoney wrote:

    Do poetic similarities between crises rhyme or are they more free form?

  • Report this Comment On November 10, 2011, at 8:04 PM, MHedgeFundTrader wrote:

    I am taking my profit in the Euro (FXE) December $140 puts this morning, nailing the high of the day at $5.70, and clocking a stunning three day profit of 107%. This adds 5.63% to the year-to-date return for Macro Millionaire, taking us up to 46%. Non option players who bought the short Euro ETF (EUO) made 9.5%.

    My net profit on the trade was $2.95. For the model $100,000 portfolio this works out to $5,310 ($2.95 X 100 X 18). And we made this return while keeping 76% of our money in cash, out of harm’s way.

    This was a perfect trade in so many ways:

    *For a start, I got a great entry point on top of a 10 cent rally in the Euro.

    *The position was a great indirect “RISK OFF” hedge for my sole remaining “RISK ON” position in the (TBT). For every $1 I lost in the (TBT) since the Thursday high at $23.00, I made made $2 on the Euro short.

    *We got an assist in the bankruptcy of MF Global, which resulted in the liquidation of their entire $6.5 billion portfolio of Euro bonds, which put additional pressure on the European currency.

    *We got a second assist from my friends at the Bank of Japan, who rushed to deflate the yen with a massive $130 billion round of intervention.

    *I resisted the temptation to take a quickie 30% profit yesterday, believing that the trading community was caught badly off balance in their positioning, and that there was enough juice to take the Euro to my secondary target of $1.36.

    *My friends at the People’s Bank of China told me they would take my advice and take down a big slug of any bond issue resulting from the European sovereign debt resolution. However, they said they would also take my advice and hedge out their Euro risk, making the trade currency neutral.

    *I initially put on the trade expecting European Central Bank President, Mario Draghi, to cut interest rates tomorrow. With the Euro at $1.3630, I now don’t care if Mario has pasta al dente for lunch, a canole for desert, and sings O Solo Mio tomorrow. I can take my money and run at let the rest of the market run the overnight event risk. If Mario then fails to act tomorrow, I will simply resell the Euro higher up.

    *We caught one of the sharpest moves in the history of the foreign exchange markets, some 5 cents in the Euro, in three trading days. You shouldn’t need to be told twice to cash in.

    *No one ever got fired for taking a three day profit of 107%. Possession of the cash is 9/10ths of the law.

    I know that some of you made more money on this trade than I did, because the $140 puts traded all the way down to $2.47 after the initial opening alert. No whining about not being able to get in this time. As they say down under “Good on You!”

    If you missed this trade for whatever reason, don’t chase it here. Another opportunity will come along. There are plenty of fish in the sea.

    The Mad Hedge Fund Trader

  • Report this Comment On November 10, 2011, at 8:19 PM, ChandlerandCo wrote:

    There were similar fears of "contagion" and "meltdown" in Asia in 1997, yet the world did not end as many predicted.

    The markets were panicked, and in one day, on October 27th 1997, the Dow dropped over 7%, putting it down 12% from its August high. Over 695 million shares were traded that day (a new record at that time). All the same senarios were predicted as they are today. Meanwhile, I was buying all I could.

    The next day, October 28th, I continued buying. The market continued its slide and then reversed itself to close up for the day, regaining much of the previous day's loss to close around 7,400 on the Dow. Over a billion shares were traded that day for the first time.

    The moral of this little story is this: Seasoned, long-term investors who have been through all this before know that the sky isn't going to fall. Fortunes are made when everyone else is panicking.

    So go ahead and sell if European debt scares you (or the U.S. debt for that matter). Let the stock markets drop. I'll be buying.

  • Report this Comment On November 10, 2011, at 9:16 PM, lollard wrote:

    We could well see attractive prices on a collection of great businesses. I'll be watching Siemens, Unilever, Total, and Banco Santander with particular attention. Anyone else have a wish list?

  • Report this Comment On November 10, 2011, at 10:12 PM, dbjella wrote:

    "The end result could be a stronger central bank, the ouster of debt-ridden countries, a unified government, or any combination of several alternatives, none of them pleasant in the near term."

    This will pave the way for politicians to start all over. Fiat money is not the answer.

  • Report this Comment On November 11, 2011, at 8:43 AM, Darwood11 wrote:

    "Will the world learn its lessons this time around?"

    No, it most certainly will not. This particular crisis will eventually ease, or morph into something else.

    The big lesson to be learned at this juncture is that there are limits imposed by slow growth economies. Another fallacy of the programs of the policy makers has been exposed - it's only possible to borrow and grow your way out of debt if your economy is growing, and growing at a "healthy" rate. Either that, or taxes must be collected to offset the borrowing. But our economically challenged politicians, and even Europe's, apparently don't know that, or expect they'll be basking in a nice retirement out of the spotlight when the music for the current dance does inevitably stop.

    All of these economies borrowed heavily but grew slowly. The current deficits in the US are similarly a consequence of this. Washington is spending as if we are adding more workers, which is more taxpayers at a "normal" rate.

    The "new normal" will probably be with us for a few years (or a decade?). That means slow growth coupled with an aging society with millions moving to the rolls of social security each year.

    CNNMoney has a short article on how economics teachers would rate the presidential candidates. Here are some of their comments:

    "I think it's grossly irresponsible what they are saying," "It's not about economics. It's about getting elected. They are promising things that are impossible to deliver or make little sense." "Neither "side" has a "truly comprehensive understanding of even basic economics."

    http://tinyurl.com/Pres-Candidates-Economics

  • Report this Comment On November 11, 2011, at 10:28 AM, TMFBiggles wrote:

    I'm glad some folks seem to have enjoyed the little bits of Yeats sprinkled through the article.

    @ ChandlerandCo -

    Your comparison is interesting. I'd like to see what others think about the current issues as they compare to the Asian Contagion crisis. I never claimed everything was going to blow up and no one would make money again, though -- just that the current setup isn't equipped to handle Italy in the same way it could handle Greece.

    It looks like the markets are expecting everything to blow over, which is somewhat surprising to me. If everyone actually does enter panic mode, I'll be buying too. I just haven't seen actual panic mode yet.

    @ slbutton -

    I hope that people freak out about PM and MCD's operations in Europe being at risk and panic sell. Would be a great time to buy. A drop in VE might be a great opportunity as well, but it's already rather low.

    @ Darwood11 -

    Good analysis. Thanks for the link!

    -Alex

  • Report this Comment On November 11, 2011, at 10:53 AM, Merton123 wrote:

    The United States during its founding had a debate about "State Rights" headed by Thomas Jeffersson versus "strong central government headed by Alexander Hamilton - - Federalists. The United States decided to go the Federalist route. Europe in contrast has decided to go the State Rights route (i.e., strong state and a weak/nonexistent central government). It looks like Europe is moving slowly but surely towards Federalism. It will be very interesting to see what finally results in a year or two down the road. .

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