Will the EU Survive This Time?

Ireland is in peril, and it's not because Dublin is running low on umbrellas or Guinness. Rather, the country's housing market is in shambles, unemployment, at 13.9%, is at a 15-year high, the government's budget deficit this year will check in at nearly 12% of GDP, and Irish banks risk collapse because of $90 billion of bad debt -- a number that's roughly one-third the size of the entire Irish economy. Not only does the Irish government lack the resources to stabilize the banks and get its economy moving again, but it doesn't look like it will be able to borrow them either.

Because of this crisis, Irish yields are skyrocketing, with 10-year Irish bond yields climbing to near 9% before a recent drop. The country, like Greece before it, looks now like it can only be saved by international intervention.

And yet ...
Irish politicians, however, are resisting a rescue, fearful of the consequences that an EU- or International Monetary Fund-led bailout might bring with it. Not only would Ireland cede sovereignty to new financial overseers in that event, but austerity measures like those imposed on Greece such as higher taxes and lower spending would almost certainly cost Ireland's ruling party its power.

While it might seem like Ireland has no chips to bargain with, the country actually has some leverage when it comes to negotiating with the rest of Europe and its central bankers. The reason for that is that the continent has already collectively committed $146 billion to prevent Greece's default in an attempt to stop the crisis from spreading to Portugal, Spain, and others and preserve the euro and European economic union. Should the EU now fail in Ireland, that money would be wasted because doubts about the stability of the euro and EU would be back. Ireland, in other words, is aware that Europe is already in for a penny and ready to go in for a pound. This means that by dragging their feet this week, they might succeed at negotiating better terms when it comes to the inevitable bailout -- a fitting development given that Ireland has long sucked money out of the EU for its own benefit without giving much in return and routinely voting against a stronger EU.

So is this the end of the euro?
Before I traveled to Germany and Greece with our Motley Fool Global Gains research team back in April to assess the situation for myself on the ground there, I wrote a column proclaiming that the euro would be dead by 2014. That was the only endgame I could foresee for a flawed idea implemented with flawed execution by flawed actors.

Yet when I got to Europe, I discovered just how wedded the current political generation there -- embodied by current European Central Bank President Jean-Claude Trichet -- was to the idea of an integrated Europe that they had spent more than a decade creating. They saw the EU as an incredible political achievement, still liked the power it gave the continent relative to the United States, and were committed to preserving it. As evidence of that fact, they'd never written into the laws governing the EU any way to dissolve it!

The euro will survive, but be worth less
That's why I changed course and now believe that European politicians today will do whatever it takes to preserve the euro and the EU. This means that larger economies such as France and Germany will ultimately end up rescuing all of the financial basket cases with whom they have chosen to ally, long-term consequences be darned! They will, however, exact some concessions from countries such as Ireland, and I suspect that the European Union of 2014 will be much more centrally governed as a result. The euro will also be worth far less, given the massive obligations that will overhang the continent and the slow-to-no growth resulting from necessary near-continentwide austerity measures.

This is why we are so fearful of European exposure at Global Gains and have recommended selling shares of companies with significant euro exposure such as Spanish retailer Inditex, cement maker Cemex (NYSE: CX  ) , and Portugal Telecom (NYSE: PT  ) .

The global view
It's also important, however, to be aware that every crisis also creates opportunity. For example, during the euro swoon last April when Greece was in the headlines, we took advantage and recommended buying shares of companies such as Philip Morris International (NYSE: PM  ) and Adidas that although they are headquartered in Europe, are becoming less and less European every quarter. At Philip Morris, for example, the EU region declined from 36.4% of net revenues (before excise taxes) in the third quarter of 2009 to 32.3% of net revenues in the third quarter of 2010 -- a trend that should continue given the company's growth in emerging markets.

That's why it's short-sighted to sell off Philip Morris, Adidas, and the likes of global liquor giant Diageo (NYSE: DEO  ) , the maker of Ireland's famous Guinness beer, with the rest of Europe. The good news is that markets get short-sighted often in times of crisis, and I'm hoping fears of the real financial crisis that Europe has on its hands with Ireland will cause these stocks to sell off again as they did when the world was worried about Greece. So add these stocks to your watchlist, and should the euro really start to drop, think about booking a lavish European vacation.

Get Tim Hanson's top global stock picks by joining Motley Fool Global Gains. Tim's "Global View" column appears every Thursday on Fool.com.

Tim Hanson is co-advisor of Motley Fool Global Gains. He owns shares of Philip Morris International. Philip Morris and Adidas are Motley Fool Global Gains selection. Diageo is a Motley Fool Income Investor selection. Cemex is a Stock Advisor pick. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (8) | Recommend This Article (20)

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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 18, 2010, at 6:09 PM, Gorm wrote:

    A country MUST save its banks. Ireland has no choice. With all the interlinking, if one fails it potentially takes others and could collapse their economy.

    There is a lesson here but our Congress seemingly doesn't get it. Instead of enacting legislation that protected "our" economy Congress sided with banks and left our economy at risk. Congress should immediately:

    1) Bust up the TBTF. These guys don't benefit consumers, shareholders or our economy. They are merely CEO ego trips.

    2) Reinstall Glass Steagal and separate investment from commercial banking. Deflate the risk exposure.

    3) Revoke the commercial charters of MS and GS. Those charters just put taxpayers on the hook.

  • Report this Comment On November 19, 2010, at 9:21 AM, TMFMmbop wrote:

    Surprise, surprise. Ireland needs -- and will accept -- a bailout from Europe.

    http://online.wsj.com/article/SB1000142405274870410410457562...

  • Report this Comment On November 20, 2010, at 7:42 AM, EuroBob7 wrote:

    Tim, you are right to suspect that Ireland denying they needed a bailout (aka loan, 'facility', help from friends) was negotiating. The ECB was getting worried by the cost of debt in other eurozone countries and pushed the issue. So there is 4 years of fiscal pain coming up with all the usual screams of anguish from the public sector. A new Central Banker and a new Financial regulator have been appointed both of whom are strong and independent replacing the two political hacks who slept at the wheel as the ship ran aground. The underlying economy however is sound and will grow if the banks can be fixed to start giving credit again. The 12.5% business tax rate will be defended to the last due to Ireland's reliance on multinational investment (>200,000 jobs). The current government are dead men walking and an election is inevitable by latest Q1 2011. Will the euro survive? I would say probably but again as the article suggests all members will have to give up more control of their affairs. Just be careful when you analyse German statements - they have an election in 2011 also.

  • Report this Comment On November 20, 2010, at 9:46 AM, xetn wrote:

    Hmmm, what country has an unfunded liability approaching $100 trillion? What country has over 20 % unemployment (if calculated the way it was originally)? What country has created over $2 trillion of new currency in the last 2 years? Lastly, what country is the largest debtor nation in history?

    Hint: it ain't Ireland or any other EU country, but you all knew that.

  • Report this Comment On November 20, 2010, at 11:25 AM, bourse wrote:

    It's no question whether the EU will survive! It has 27 member countries and only 17 of them have adopted the Euro!

    For the EU as a whole there is no real alternative and all know that. The single European countries alone would only be little toys in the hands of global powers as China, the US or even India.

    But will the European monetary union survive?

    Certainly, politicians will try to save it as the Euro always was "politicial" money. But how long can politics resist the natural law of gravitiy??

    The peripheric countries in Europe are loosing competitivness rapidly. This means transfering always more money to these countries from Germany and the Northern countries. How long will their taxpayers accept this?

  • Report this Comment On November 21, 2010, at 6:28 PM, Zaneyjaney wrote:

    Tim, you recommend selling shares of companies such as Portugal Telecom. I suppose this would apply too to, say, France Telecom? Or is France, as one of the stronger EU countries financially, somehow in a better position to weather the storm?

    Either way, I think you're right -- a trip to Ireland just might be the ticket! Sure and begorrah!

  • Report this Comment On November 22, 2010, at 9:02 AM, TMFMmbop wrote:

    France Telecom is another to be wary of even though, like Telefonica, it has some exposure elsewhere in the world. Given the way the euro is dropping right now, this stands to be a tough day for European names.

    Tim

  • Report this Comment On November 26, 2010, at 10:36 AM, Mstinterestinman wrote:

    I picked Up NBG at 1.78 small position at this level I either double my money or they go bankrupt but that is unlikely the EU is going to prop up whoever they can to stabilize things. I have been eyeing Diaego booze will never stop selling and they are one of the best in Europe.

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