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Here's How Europe Turned Into a Train Wreck

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Wrapping your head around the European debt crisis can be quite a headache, and all that commotion can be hard to follow at times. What with austerity packages, government strikes, and bond yields, it feels likes there's no end in sight.

Just in the last couple of weeks, 10-year bond yields in Spain approached 6% and the country declared itself officially in a recession; France took a step closer to electing a socialist president skeptical of austerity; and the Dutch government fell apart over budget cuts that would bring its deficit under 3% of GDP, as the eurozone mandates.

With trouble across the Atlantic roiling American markets once again, this seems like a good time to take a look back at the mess that has become the eurozone.

How it all began
International banking collapses often lead to sovereign debt crises, and this time around was no different. The Great Recession and the destabilization of financial markets pushed European deficits to unsustainable levels, and the shared currency put a further bind on the more profligate countries as they could not pump more money into their economies nor could they let their currencies float to encourage exports.

In 2008, only Greece and Ireland had deficit-to-GDP ratios above 6% -- twice the EU's limit -- but by 2009 nine EU countries broke the 6% threshold, with Greece the biggest offender at 15.8%. In October of that year, new Prime Minister George Papandreou revealed that his predecessor had been understating the deficit for years. Credit downgrades soon followed, and government officials and union members began striking against austerity measures such as an increase in the retirement age. In May 2010, Greece received its first round of bailout loans, totaling $152 billion from the eurozone and IMF.

We can see the Greek crisis play out through the lens of stocks like the National Bank of Greece (NYSE: NBG  ) and DryShips (Nasdaq: DRYS  ) . The National Bank of Greece traded above $40 before Papandreou revealed the deficit bubble and has since sunk to near $2, while the Greek shipper traded above $100 before the financial crisis and now goes for about $3. Greek stocks experienced none of the recovery that other markets did after the financial crisis, and the Athens Stock Exchange Index is now worth just 15% of what it was five years ago.

Elsewhere on the continent...
While Greece was spiraling out of control, foreboding signs from Spain, Portugal, and Ireland appeared in the form of contracting growth rates, bank bailouts, and debt downgrades. Throughout 2010, the euro continued to drop to lows against the dollar not seen in several years, and in November, Ireland received an 85 billion euro bailout from the EU and IMF and passed the country's strictest budget in history.

In May 2011, Portugal became the third eurozone country to receive a bailout, getting 78 billion euros, and during that summer Greece received its second round of emergency loans, this time for $157 billion. Soon after, yields on Spanish and Italian bonds jumped, and the European Central Bank announced it would buy those bonds to help control borrowing rates. Fears of a double-dip recession abounded in September after data showed the eurozone's private sector declined for the first time in two years.

In January 2012, after several rounds of talks failed to produce effective results, the S&P downgraded the debts of nine EU countries as well as the eurozone bailout fund. Fears of falling into another recession raged in the proceeding months as data showed negative growth in the continent and a record-high eurozone unemployment rate in March. The following week Greece received a third bailout of 130 billion euros, and in April, Italian and Spanish bond rates rose again, stoking new fears about their countries' solvency.

How we stand today
Attention in recent weeks has focused on the struggling Spanish economy, which recently dove back into recession due in large part to its record high unemployment rate of 23.6%, the highest in the eurozone. Investors in Spanish heavyweights like Telefonica (NYSE: TEF  ) and Banco Santander (NYSE: STD  ) have felt the pain, as shares of both companies have been sliced in half over the past year. Unlike in other suffering eurozone countries, which became victims of their own debt burdens, a housing bubble was central to Spain's epidemic as home prices grew 44% from 2004 to 2008. Once the bubble burst, the construction sector fell apart with it, and now the government is trying to fill the huge deficit created by the jump in unemployment benefits and the loss of tax revenues.

On the whole, the eurozone seems to be caught in a macroeconomic Catch-22. Further austerity measures may jeopardize economic growth, but an economic stimulus, as U.S. Treasury Secretary Tim Geithner and others have called for, will only add to the debt rolls. A looming demographic crunch also awaits the continent if it can make it past the debt crisis. Low birthrates and generous entitlements are likely to further constrain budgets as some European countries' populations should start falling by 2015.

Where do we go now?
Now may be Europe's moment of truth. Much praise can be heaped on a region that's gone from twice laying waste to itself in the first half of the 20th century to joining under the same currency and collectively forming the world's biggest economy. In the end, though, the current struggle to stay together may prove as formidable as any other challenge the continent's faced.

In the days to come, elections in France, the Netherlands, and Greece will help clarify the next steps in the debt crisis. French Socialist candidate Francois Hollande narrowly won the first round of presidential elections and favors growth-oriented measures over more austerity. The French will go to the polls on May 6 to select their president. Greece will also vote in a new government the same day to replace the interim administration that followed former Prime Minister Papandreou, who was pressured out last year by France and Germany. Poll watchers expect a coalition government to result. Elections in the Netherlands will also likely take place soon, after its government fell apart Monday following disagreements over budget cuts.

Finally, as Spain teeters, some have suggested that it may need a cash injection, which would drain the eurozone bailout fund since Spain is much larger than any other country that's received a bailout.

For now, in this age of globalization all eyes remain on Europe. Just as the U.S.-based financial crisis rocked the world economy, a true recovery would have to extend across oceans as well.

While Europe may only be suitable for the hardiest of investors these days, our experts at the Fool have found a group of American brands that have been reaping huge rewards abroad. These companies are consumer favorites whose products you've likely spent your own hard-earned cash on. And with the huge emerging middle classes in China and India, they're poised to pounce on over 2 billion new consumers craving the status of foreign brands. Get the scoop on these hot stocks in the Fool's latest special free report: "3 American Companies Set to Dominate the World." You can get it now by clicking right here.

Fool contributor Jeremy Bowman holds no positions in the companies in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (5) | Recommend This Article (8)

Comments from our Foolish Readers

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 April 26, 2012, at 5:41 PM, jesterboomer wrote:

    Most of the European and US economic wounds are self-inflicted by a slavish belief that it is good to limit the money supply even as trillions of $'s have been wiped off asset values and banks reduce lending.

    The solution is easy - print more Euros and distribute them equitably throughout Europe, e.g. based on GDP. Print 10% of GDP and devalue the Euro by 10%. Problem solved and Europe becomes internationally more competitive.

  • Report this Comment On April 26, 2012, at 6:03 PM, minnjim1 wrote:

    Adopting a single currency for all the diverse EU nations was an ignorant and irresponsible act. As we have now seen, the euro is untenable and must be abandoned. Cut the nations loose and let them float their own currencies. Problem solved.

  • Report this Comment On April 26, 2012, at 6:23 PM, DJDynamicNC wrote:

    Jesterboomer: +1 for that comment.

    This sentence is the crux: "Further austerity measures may jeopardize economic growth, but an economic stimulus, as U.S. Treasury Secretary Tim Geithner and others have called for, will only add to the debt rolls."

    The austerity that has been practiced has clearly jeopordized (indeed, evaporated) economic growth. The issue here is that increased unemployment and social anguish increases the deficit by cutting tax receipts and can increase rates by cutting investor hopes for the future - in fact, you go on to end the article by pointing out that only the hardiest investors are interested in Europe right now, which is precisely what causes rates to climb. That means we have two options:

    1) Borrow to finance a stimulus and work on growing the economy. This could raise rates and devalue the euro (devaluing the Euro would be quite a boost for countries like Greece, I might add) and it will add to the debt, but is likely to reduce human suffering and help break the cycle.

    2) More austerity. This is likely to hurt economic growth, which is likely to raise rates and add to the deficit.

    So in other words, add to the deficit and increase rates but help fix things, or add to the deficit and increase rates but make everything last longer and hurt more.

    Curious that they're going for option 2 over there. The best is when they say that they can't borrow because that could cause borrowing costs to rise. Why do you care what borrowing costs are if you're not going to borrow anyway?

    PS: The article switches from dollars to Euros a couple of times, sometimes even in the same sentence. That makes it harder for us to compare accurately (and might just as well be a typo by somebody used to hitting the dollar sign - it's hard to tell). This is offered as constructive criticism for future reference.

  • Report this Comment On April 26, 2012, at 6:45 PM, ybnvsfool wrote:

    No mention of the rampant government spending. No mention of the greed of individuals demanding long vacations, high wages, very early retirements and huge pensions.

    Just another good reason that the US should not have a FICA system (a robbed lock box ponzi scheme) or a Medicare System ( If you think health care is expensive now, just wait until it is free). Just pass the problem on to our children because it is easier to give someone elses money away than it is to solve the problem. We have some hard choices ahead of us and more spending and more government is not the answer.

  • Report this Comment On April 26, 2012, at 6:55 PM, xetn wrote:

    "Much praise can be heaped on a region that's gone from twice laying waste to itself in the first half of the 20th century to joining under the same currency and collectively forming the world's biggest economy"

    The grand Socialist's dream. And you can now see the results of the dream (nightmare).

    You have the strong economies (Germany) bailing out the European Banks who loan 100% on any government's bonds, including the PIGGS!.

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