“Be assured, my young friend, that there is a great deal of ruin in a nation.”
— Adam Smith, 1777
With the benefit of hindsight, we know that the 1800s were the best century in the illustrious history of the British Empire. The loss of the American colonies proved to be little more than a speed bump in Britain’s rise to global ascendency. The rebellious 13 that went on to form the United States were quickly replaced with new colonies strewn across every corner of the globe. At home, Britain’s evolution toward consumer capitalism and constitutional monarchy allowed it to avoid the violent social revolutions that swept across France and much of continental Europe. And abroad, Wellington’s army defeated Napoleon and established the Pax Britannica that would define the global order until the outbreak of the First World War.
But in 1777, the future looked far from bright. Britain was not the global superpower, but rather one of several competitors for that distinction. The country was bleeding itself dry in North American wars, first against the French and then against its own colonists. This is what led the young John Sinclair to lament to Adam Smith that “If we go on at this rate, the nation must be ruined,” which elicited Smith’s skeptical reply above.
Smith’s point was that a strong nation can survive quite a few setbacks and bad decisions by its leaders, and history has proven him right time and again. As a case in point, let’s move away from Smith’s native Britain to the United States. During the U.S. Civil War, the Union army was run by some of the most incompetent men to ever wear a uniform, yet the North was able to conquer and subdue the South because it was an inherently stronger country. No matter how “out-generaled” the Union Army was by the Confederates, it didn’t matter. The economic system of the North was so much stronger than that of the South, the Yankees could afford to engage in a grind-it-out war of attrition. The Rebels never had a chance.
Sometimes it comes down to geography, too; Napoleon and Hitler never had a chance against Russia. Despite being out-generaled and having a much weaker domestic economy, Russia was able to win a war of attrition in both cases by virtue of having one of the most miserable winters of any country in the world.
Why do I bring any of this up? Because today I believe there is quite a bit of ruin left in the euro zone and its much-maligned currency. Despite the best efforts of its member states to damage it beyond repair, the euro will survive.
This is not to say that its value will not fall from current levels relative to the dollar and other world currencies, of course. In fact, that is exactly what I expect will happen. I am surprised the euro hasn’t already fallen to parity with the dollar, and the fact that it hasn’t is testament to how bad things are on this side of the Atlantic. But I repeat: There will be no disorderly breakup of the euro zone or of the broader European Union. To borrow what Winston Churchill said about the Americans,
“European politicians will do the right thing after exhausting all other options.”
Those options, by the way, have indeed been close to exhausted. Yields on Italian and Spanish debt remain uncomfortably high, and even mighty Germany had a hard time selling its bonds two weeks ago. This crisis needs to get resolved in a hurry.
As events unfold, it’s looking like a two-pronged solution is taking shape that involves some sort of “fiscal union” at German insistence that would give the EU the ability to regulate the budgets of profligate member states. The second plank is an expansion of the European Central Bank’s role in acting as a lender of last resort. Already, the ECB has joined forces with the central banks of the United States, Britain, Canada, Switzerland and Japan to stabilize the interbank lending market. Our central bankers want to avoid a repeat of 2008, when terrified banks stopped lending to one another and the world financial system ground to a halt. The ECB’s role will need to be expanded, however, to include making much larger purchases of bonds in the secondary markets.
I am under no illusion that any of this will be easy. Either change will involve making revisions to the European Union’s governing treaties, which will involve the ratification of all 27 member states. As the last round of constitutional reform proved, this can be difficult even in less chaotic times. Nationalist and Euro-skeptic parties will protest EU involvement in national finances, and “hard money” countries like Germany and the Netherlands will find it difficult to accept a larger mandate for quantitative easing. Expect months of drawn-out debate as many of the EU’s 27 member states will have to hold referendums. Given the seething anger that Europeans feel toward their leaders these days, the outcomes are far from certain.
Still, when presented with the alternative — a disorderly unraveling of the entire European project — I expect cooler heads to eventually prevail. But I also expect there to be plenty of setbacks and “mini-crises” along the way. As investors, this likely means more wild swings in stock prices — and plenty of good trading opportunities.
Hold on, investors. The first quarter of 2012 promises to be anything if not interesting.
Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. Sign up for a FREE copy of his new special report: “Top 5 Contrarian Stocks for 2012.”
