Is This the Collapse of the Eurozone?

For those not following the sovereign debt crisis overwhelming most of Europe, I'll give you a quick rundown. Greece, one of the 16 countries that make up the Eurozone, spent more money than it had -- and the money it spent was borrowed money. The more it borrowed, the higher the interest rates it received on its loans, until it became painstakingly obvious that this was not sustainable.

After it was revealed that Greece had … errr … erroneously fudged some numbers, the country's true fiscal picture became clear: In 2009, Greece's budget deficit clocked in at about 12.7%, and its national debt as a percentage of GDP has reached about 125%.

Who cares?
Well, for one, all of the other members in the European Union care. All 16 countries signed a "Growth & Stability Pact," drawn up to ensure that all members stay on the straight and narrow path toward fiscal responsibility. The two criteria imposed on members are they have an annual budget deficit no more than 3% of GDP, and a national debt lower than 60% of GDP.

Hmmm, looks like Greece has broken both of those rules. The problem is, so has almost every other member in this motley crew of countries. Although the objective of the growth pact was well intended, the rules have never been enforced, so there has never been any incentive for fiscal conservatism.

As an investor, you should also care -- for two reasons. First, Greek companies are understandably feeling the pressure of their governments inability to reign in debt and balance the books. In the last week, Greek companies like DryShips (Nasdaq: DRYS  ) , National Bank of Greece (NYSE: NBG  ) , and Capital Product Partners (Nasdaq: CPLP  ) have all seen their share prices drop. Is this a buying opportunity, or do these companies deserve to be hammered because of the irresponsibility of their government?

Second, if you believe like I do that the euro is going to come under extreme pressure, then you'll want to watch your exposure to euro-centric companies like Philip Morris International (NYSE: PM  ) or Vodafone (NYSE: VOD  ) . And I'm not necessarily advocating this last approach, but if you really want to take advantage of the crisis, you could short the euro by investing in ETF's like UltraShort Euro Pro Shares (NYSE: EUO  ) or Market Vectors Double Short Euro (NYSE: DRR  ) .

When PIIGS fly
So where do we go from here? Well, there are basically three options that the EU has in order to get itself and Greece out of the current mess:

  • EU members can bail Greece out.
  • Greece can go to the International Monetary Fund (IMF), hoping for a loan and a lighter than usual slap on the wrist.
  • A European Monetary Fund (EMF) is created by the EU to act as a lender of last resort.

Don't look for EU members to bail out Greece. Germany, the de facto leader of this bunch, has made it clear that it does not want to reward capriciousness. In addition, the EU has a "no bailout" clause, which more or less says that no country's liabilities should be assumed by the EU. Angry with Germany's unwillingness to play nice, Greece's deputy Prime Minister -- no stranger to controversy when, in 1993, he referred to Germany as a "giant with a child's brain" -- recently resorted to Nazi-era rhetoric blasting the Germans for stealing their gold during WWII.

So, call me skeptical on the prospects of a German-led EU bailout.

Greece may just go to the IMF. Originally, I didn't think it would because of the stigma attached to taking a handout -- and the imposition of austerity measures required by the IMF. However, Greece has made it clear that it would get much lower interest rates (maybe around 3.25%) than it would on the open market (closer to 6%). Nevertheless, I have a feeling the EU has too much misplaced pride to allow one of its own to ask the IMF for help.

The last option seems more and more feasible. German Chancellor Angela Merkel has said that "the idea [of an EMF] is a good one." Yet in order to do create an EMF, Germany is pushing for a rewrite of the EU treaty -- not exactly an easy task, considering the intense politicization of the process and the nationalism that typically overrides EU solidarity. Creating an EMF would be popular on the one hand because it would allow EU members to solve these types of problems on their own, and on the other hand would calm debt markets by providing a financial backstop.

However, Germany also wants to include a retroactive "exclusion pact" that has the power to kick out current EU members that aren't living up to EU standards. Any talk of exclusions hints at widespread frustration and a major disconnect between members. Moreover, an EMF would also send a terrible signal to the other members of the EU that are currently on the precipice of disaster.

Yes, Greece is not the only one in trouble. The PIIGS -- Portugal, Italy, Ireland, Greece, and Spain -- all have broken covenants regarding deficits. They all have enormous amounts of debt coming due and will most likely be facing a similar crisis in months to come. Check out this chart of the upcoming liabilities due this May:

Source: Spiegel Online via Wall Street Pit.

The worst possible scenario -- and one that is growing more and more likely with every day that EU members spar over differences -- is that once the EMF is created, troubled countries rush to maximize any benefits they hope to receive. Anticipating a run on the fund, distressed countries will dash to the EMF as they try to deleverage their balance sheets. The fund, this early in its infancy, would most likely not be able to sustain such a panic.

IMF Managing Director Dominique Strass-Kahn has said "modest reforms that maintain a pretense of progress but continue business as usual are not sufficient ... Europe needs a fundamental overhaul of its financial stability architecture." Whatever option is chosen, whether it's a combination of an IMF/EU loan package, or the creation of a new EMF, it's clear that this whole thing is a big row of dominoes just waiting to fall.

This morning one domino actually tumbled: Fitch downgraded Portugal's debt. Although the markets seem to have expected the downgrade, it's yet another sign that as one country goes, financial exposure throughout the EU will be uncovered and the lack of fiscal federalism will serve to ripple its way through stormy EU waters. And Ireland looks to be next in line.

The Foolish bottom line
The Greeks are threatening to go to the IMF for aid, a gesture that humiliates other EU nations. The Greek Prime Minister, however, refutes this fact and insists that the EU must resolve the problem when the EU meets this Thursday and Friday in Brussels. The Germans have established their stance as "Heck no, we're not writing the check!" The French are flabbergasted and want to help Greece. The Netherlands is siding with the Germans.

The result: a Eurozone that is even more discombobulated and segregated than it was when the Treaty of Maastricht took force in 1993, with  a currency that's hitting all-time lows.

If this is the beginning of the end for a group of disgruntled, stymied countries, get ready for a major change in the financial world order. Keep your investments limited to companies with minimal exposure to the euro, and watch for the flight to safety in the good old U.S. dollar. European sovereign debt may just implode before we know it.

Want updates from a team of Fool analysts who set off to Greece to get answers on the crisis? We're documenting all of the Fool's Greek research in real-time at www.FoolGreece2010.com. That includes what we're hearing from companies and investors as well as first-hand, on the ground accounts of what's going on!

Fool contributor Jordan DiPietro owns no shares mentioned above. Philip Morris International is a Motley Fool Global Gains pick. Try any of our Foolish newsletters today, free for 30 days.


Read/Post Comments (16) | Recommend This Article (47)

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 March 24, 2010, at 5:30 PM, ryanalexanderson wrote:

    >...and watch for the flight to safety in the good old U.S. dollar.

    Not to sound like a bug or anything, but some may also just fly right by the dollar into the cold yet oddly comforting embrace of precious metals.

    Once someone gets jolted out of the illusion that a "motley group of nations" can only bail out one another so much, it's not hard to see that a "motley group of states" won't do much better! Especially when its the bigger ones like California so deep in the toilet.

  • Report this Comment On March 24, 2010, at 5:55 PM, wigglestick wrote:

    Sadly, it took a "crisis" (the Greeks) to expose the fraud that has become the Eurozone. While I believe the initial run-up from $0.80 to $1.60 might have been warranted, the fundamentals haven't supported this value for a very long time. Just two months to the collapse, I put ALL my spare money into US$ (after purchasing Euros when the Cdn $ hit a 35-year high). When the rush to safety occurred as anticipated, I kept these same US$. Imagine my shock at the unsupported fundamentals pushed the euro and CDN $ higher (in the CDN $ case, much much higher than is warranted and that is good for our economy). I knew it was only a matter of time before the real picture emerged though, so kept long on US$. My husband and I are going to Europe for 6 months (leave this monday), partly, though not determinant factor, of a $1.20 to par Euro. Yes, you heard it here first. Don't forget, as the US$ strengthens, oil (and other commodities decrease in price, strengthening the US$ further, and weakening other currencies, in particular the Euro and CDN$). Further, I am in Calgary, the business centre of the filthy lucre of the oilsands. There's big trouble in the oil patch and the Canadian economy, all papered up. Our govt. had to tighten the lending rules because the CMHC (our Freddie Mac) was going to run out of $$ to backstop the loans, and this is AFTER the govt. fed it close to $400 billion to keep things going. My prediction for this is that things are going to go down rapidly here as well (historically high deficit, massive pension shortfall growing worse by the day, personal debt level of 142% - higher than the US 129% at its peak - of ordinary Canadians). If you've made a profit on Cdn$ or Euros, I suggest you take it now and turn around and short both to make yet more over the coming months. Canada is NOT the darling that is being espoused, just the traders pushing shite so they can make a huge return. The fundamentals, however, don't support the value. You've been warned!

  • Report this Comment On March 24, 2010, at 6:01 PM, ryanjmorrell wrote:

    Dryships does not rely on the Greek government and I don't understand why you would want them to get hammered down when trying to correlate the two together when one does not depend on the other. If you know how dryship receives its income you would already know this which makes me question your knowledge and credibility on this article in regards to specifically Dryships.

  • Report this Comment On March 24, 2010, at 6:13 PM, DoubleDutch102 wrote:

    It seems to me that Mr. Di Pietro is getting a bit overexcited; the Euro has fluctuated between $0.85 (2000) and $1.60 (2008) and is thus at present not anywhere close to an "all-time low"! Business in Europe was complaining loudly at the (unsustainable) $1.60 rate and I think we should feel quite comfortable with an exchange rate between $1.20 and $1.40

  • Report this Comment On March 24, 2010, at 6:50 PM, TMFPhillyDot wrote:

    @ryanjmorrell,

    I did not say that DRYS relies on the Greek government; I also did not say that I wanted them to get hammered down. I am not sure where you misunderstood my point, which was this:

    (a) they could possibly see price decrease because they are a Greek company, and in fact, they do hire Greek employees (which is only one of many ways they are exposed to Greek economy)

    (b) A substantial portion of their business is tied to the economic success of the EU (not just China and U.S.)

    (c) 50% of their operating costs are expressed in the Euro, so they are very much exposed to currency risk.

    Maybe I could have chosen a better company than DRYS, but I still feel it is certainly relevant.

    Thanks for the comment.

    Foolishly,

    Jordan (TMFPhillyDot)

  • Report this Comment On March 24, 2010, at 7:31 PM, sixty9harley wrote:

    Dryships Greek connection? There is NONE.

    The ships are built in Asia.

    The debt in held in Europe.

    The crews are from who knows where.

    DRYS is a Marshall Island Company ( out in the middle of the pacific ).

    The shareholders are mostly USA.

    The only connection this company has with Greece is the rented home office and the CEO's heritage & residence.

    But stupid reporters keep lumping this stock in with Greece debt crisis. Dryships has it's own debt problems but it has nothing to do with Greece.

  • Report this Comment On March 24, 2010, at 7:57 PM, PositiveMojo wrote:

    I'm surprised that everyone acts like this is a new problem - it is not. As recently as 1982 Mexico announced it was unable to pay its debts. The effect was a significant devaluing of the Peso and a rescheduling of the debt by other nations.

    The same will happen in this case since this is neither a unique or historically uncommon event. To be sure - the people of those mis-managed countries will suffer for a time.

    This should serve as a warning for our leaders in Washington - but I'm afraid with the socialization of the universities they may have missed that lesson.

  • Report this Comment On March 24, 2010, at 7:57 PM, PositiveMojo wrote:

    I'm surprised that everyone acts like this is a new problem - it is not. As recently as 1982 Mexico announced it was unable to pay its debts. The effect was a significant devaluing of the Peso and a rescheduling of the debt by other nations.

    The same will happen in this case since this is neither a unique or historically uncommon event. To be sure - the people of those mis-managed countries will suffer for a time.

    This should serve as a warning for our leaders in Washington - but I'm afraid with the socialization of the universities they may have missed that lesson.

  • Report this Comment On March 24, 2010, at 8:08 PM, Gorm wrote:

    The deceit, the cover-up is one thing, but the underlying inability to live within its means, correct CORE problems ( downsize government, wring in pension, entitlement costs, tax those who don't pay) suggest NO solution is on the horizon.

    While a country has taxing authority I see this as little different than lending to a credit card junkie looking for relief so he can resume the same pattern.

    Countries, like individuals, need to understand rules and personal responsibility, assume accountability and quit feeling they are the entitled exception!!

  • Report this Comment On March 24, 2010, at 8:15 PM, Gorm wrote:

    Why is it countries, like individuals, believe they are the entitled exception? Rules are there for a reason. Countries, like individuals, should act responsibly, take ownership and FORCE member countries to adhere to the rules under defined penalties for non-compliance.

    Do you believe that if Japan, China, UK demanded that the US get its financial house in order under penalty of a stiff rate premium Congress would actually get the message?

  • Report this Comment On March 25, 2010, at 1:20 AM, joandrose wrote:

    Graybear 1951

    Mexico was able to allow the peso to devalue because the peso alone was affected. Greece is now using the Euro as their currency. They no longer have their "own" currency - the Drachma.

    The Euro cannot be allowed to devalue without affecting the entire membership of the Eurozone - not just Greece.

    Sorry - am I missing something?

  • Report this Comment On March 25, 2010, at 9:22 AM, succer wrote:

    We here in Europe are very happy with our lowering currency. Thanks to CDS's Greece (and others) have to make their homework correct now. On the other hand the lower € is good for our economy. Our target is a 1/1 relation with the $.

    The big winner becomes then our economy.

    Guess who will be the looser.

    We kindly thank all the banks that will make this happen.

  • Report this Comment On March 25, 2010, at 4:19 PM, MNU34 wrote:

    German exported did not have a really difficult time with American competition at FX =1,5. Guess what happens at 1,30 :-).

    So I do not understand why the US is so excited

  • Report this Comment On March 26, 2010, at 3:11 AM, MeHow5r wrote:

    Succer,

    the loser will be the European project. The world will not have so much trust in the EUR any more, the plans to push out the USD as world's reserve currency will fail. The core problem of the EUR being suitable for Germany and BeNeLux and not suitable for the rest will persist and will cause more inefficiencies in the European economies. The euro zone is becoming Mitteleuropa, so the big winner is Germany and its economy. I understand your excitement if your German, cos I think Germany is about to have a great decade.

  • Report this Comment On March 26, 2010, at 3:13 AM, MeHow5r wrote:

    MNU34,

    German and Dutch - yes. The rest of the euro zone had massive problems.

  • Report this Comment On March 26, 2010, at 6:17 PM, MNU34 wrote:

    I am not so sure. Austrian industry is at least as competitive as Germany. Slovakia has internal demand issues, but is doing all right.

    OK, I do not really know what France, Spain, Portugal would want to export other than things to eat and wear. Maybe here you are correct.

    Anyways Italy is the most interesting one. The north is definitely more competitive than Germany on average. So with this logic there needs to be a different currency for regions with different competiveness, Italy would need 2 currencies and Germany 2-3.

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