It's Do-or-Die Time for the Eurozone

At the Versailles Conference after World War I, economist John Maynard Keynes believed that the intense desire by Britain and France to crush Germany would eventually result in economic ruin for Europe. He laid out his case against the subsequent Versailles Treaty in The Economic Consequences of the Peace, where he concluded, "Who can say how much is endurable, or in what direction men will seek at last to escape from their misfortunes?"

The question of how much is endurable is one that could easily be applied to much of southern Europe today. In Spain and Greece, unemployment is now at 24.3% and 22%, respectively. And more than half of all young workers in those countries do not have jobs. Making matters even more complicated, yields on sovereign debt in Spain and Italy are at unsustainably high rates, which do not allow their governments much flexibility in aiding their troubled economies.

Things are getting worse
Conditions in Greece are perhaps worst of all. A recent article in The New York Times painted a grim picture of the economy there. For example, Coca-Cola saw its Greek-based distributor -- Coca-Cola Hellenic (NYSE: CCH  ) -- downgraded due to the possibility of Greece leaving the eurozone, while the French supermarket Carrefour decided to sell its entire stake in Greece so it could concentrate on other markets. And the pharmaceutical company GlaxoSmithKline (NYSE: GSK  ) and telecom firm Vodafone (Nasdaq: VOD  ) are actually "sweeping" money out of Greece and into Britain each night. Businesses and investors are literally preparing for the worst, and the people of Greece are suffering as a result.

The deteriorating condition of much of Europe is the backdrop for tomorrow's European Summit, which is tasked with somehow preventing catastrophe. Some observers believe that a dramatic solution is needed right now or else the eurozone will be torn apart in a matter of months. Sadly, a painless outcome at this point seems highly unlikely. And that will mean significant market volatility for investors in the near future.

This time it's different
Time appears to be running out for the euro. For many investors it has seemed like the eurozone crisis will muddle along forever without causing too much collateral damage. Somehow -- many of us seem to think -- it'll all work out in the end. This outlook, alas, is no longer tenable. We may have finally reached the point where something has to change.

In a very influential talk recently, George Soros argued that the European authorities "have a three months' window during which they could still correct their mistakes and reverse the current trends." By fall, Soros expects the Greek crisis to reach a climax, while increasing German economic weakness might make it even more unlikely that Germans will "accept any additional European responsibilities." Martin Wolf, one of the leading writers on European affairs, feels that Soros is correct about the amount of time left, and feels that it is "perfectly possible that the time needed to sort out this mess is very brief."

What's needed might be unlikely
So what is needed to save the eurozone? Soros, Wolf, and many others believe that developing a banking, fiscal, and political union is essential for preserving the eurozone. The economist Anatole Kaletsky summarized the challenge succinctly by writing, "A single currency can only be sustained within a fiscal and political union that can mutualise and monetize the debt." Kaletsky also notes that this is something that "Germany refuses even to discuss."

We shall soon see about that. Herman Van Rompuy, president of the European Council, has just put forward a plan that urges the eurozone to make progress toward a banking union, fiscal union, and political union (link opens PDF file). Such a plan will require considerable buy-in on the part of Germany, and initial indications from Germany's Chancellor Angela Merkel are not encouraging. To make matters even more worrying, a recent report shows that 39% of Germans favor leaving the euro compared with just 28% of Italians and 24% of Spaniards.

What does this mean for investors?
U.S. markets have been mixed since Greece's crucial election over a week ago, with both the Dow Jones Industrial Average (INDEX: ^DJI  ) and the S&P 500 (INDEX: ^GSPC  ) down around 2% or so. Both indexes had a great start in 2012 only to give up a lot of those gains in the second quarter.

The outlook for the remainder of the year is uncertain, though I suspect volatility will increase significantly in the coming months. Growing the global economy while the eurozone crisis continues to fester is like trying to drive uphill with the emergency brake on. And the likelihood of a positive outcome in Europe seems very low at the moment.

My best guess is that Europe will try to muddle through, as they've been doing for the past few years. I'm not sure this approach will work this time, however. The next crisis in Greece or Spain or Italy might be larger and more intractable than the ones in the past, and that could have an extremely negative impact on global markets. Economist Nouriel Roubini said recently that it's time to "batten down the hatches." If the European leaders are unable to make progress at the summit, he might be right.

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John Reeves does not own shares in any of the companies mentioned above. You can follow him on Twitter @TenBaggers. The Motley Fool owns shares of Coca-Cola. Motley Fool newsletter services have recommended buying shares of Vodafone Group Pl and Coca-Cola. 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.

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  • Report this Comment On June 27, 2012, at 1:18 PM, Darwood11 wrote:

    I'd suggest the title of the article should be "It's Do or Die Time for the Eurozone, Again!"

    I think that's the way the European Elite, which is to say those in the catbird's seat, see it.

    I agree with the sentence "My best guess is that Europe will try to muddle through, as they've been doing for the past few years."

    I also agree that this has become an impossible situation. We're not too far away from anarchy and why not? If one has zero chance of employment in a completely dysfunctional system, then revolution is a way to go. If one is faced with severe cuts to public aid, what else can one do?

    This is not rocket science, But it is becoming a battle between the "haves" and the "have nots."

    We have recent experience here in America, if we're willing to look for it. A lot of people in American are completely unaware of some the the ugly situations that occurred as a consequence of Katrina. No, I'm not referring to New Orleans. I'm talking about lovely, middle class communities which were cut off from electricity, water and food. If your family was facing ruin, or worse, what would you do? If you family was facing starvation and had no water, etc. and you were a middle class suburbanite, what would you do?

    After Katrina, it got really ugly for a lot of people. But you didn't know that, because all eyes were on NOLA, and that's what our popular press reported as "news."

    Many Europeans face similarly difficult and very hard choices, When it is starve or fight, I guarantee the reader that many will choose to fight.

    There are a lot of Europeans, removed from the problem and quite comfortable. They are playing with fire.

    Same is true for our politicians here in America,

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