3 Final Scenarios for the Eurozone Crisis

This act could play out in several ways — and all still have risks

By Jeff Reeves, Executive Editor of InvestorPlace.com


eurozoneWith each passing week, we get deeper into the debt crisis of Europe — and it’s more and more difficult to see the light at the end of the tunnel.

Making matters even more complicated is the steady drumbeat of news making it incredibly difficult to comprehensively assess the situation, since Europe is very much in flux. Throw in the many factors at play — from the fallout for financial stocks to bond markets to European import trends, just to name a few — and it’s no wonder the global markets are so uncertain.

3 High-Risk, High-Reward Eurozone Stocks
3 High-Risk, High-Reward Eurozone Stocks

But here’s the thing: Unless you are a very active trader looking to pinpoint specific areas of risk and opportunity, there’s little to be gained from having your eyeballs glued to the headlines. The fact of the matter is that despite the many moving parts and varied scenarios, there are really only three ways the EU debt crisis can end.

Yes, the devil is in the details — and with 17 euro-denominated member states with their own political agendas, those details aren’t going to be easy to hammer out. But if you are more concerned with the possible endings to this mess than the constant action of the present, here are the bottom-line scenarios:

Scenario 1: The EU and Euro Survive

General Result: This is the best-case scenario, and the one France and Germany are most hopeful of achieving. Whatever the specifics, the European Union will remain unified under a joint currency and provide stability. In a perfect world, the EU maybe will even emerge stronger than before.

Some Items at Play: All governments must be OK with strict borrowing rules for this to happen. Member states and their voting publics also will have to be OK with bank bailouts. And most importantly, after this is done, confidence needs to return as businesses and EU consumers spend again and grow Europe out of its debt troubles and current recession.

Variations: Survival of the European Union doesn’t mean that the status quo needs to persist completely. Movement away from individual countries issuing sovereign debt and toward a “eurobond” system could be part of the plan. This will spread the risk of borrowing around the continent to prevent such a crisis from occurring again. Another variation would involve a fully integrated political union as well a monetary union. We’re talking a government with clout here, which would not only focus the region on collective desires instead of national interests … but would prevent some of the messy local politics we saw in Greece and elsewhere, since governments will be formally aligned on a higher level.

Benefits: Confidence is the No. 1 takeaway here, since avoiding a breakup will provide stability to businesses and investors. Also, no country has to deal with devaluing its currency or wandering in the wilderness until it gets its act together.

Risks: Inflation is the biggest problem here, since the euro already is plummeting and the European Central Bank will have to print a boatload of cash to prop up the continental system. There also is a risk that governments won’t clean up their spendthrift ways after a bailout, having proven that they will be given a leg up if they overreach. And if inflation gets out of control, the result could be an intact EU that has to deal with years of economic hell as businesses go bust and wages can’t keep up with inflation.

Scenario 2: The Eurozone Sees a Partial Breakup

General Result: Rather than throw their lots in together, the European Union essentially puts some or all of the problem nations on an iceberg and pushes them out to sea. That creates a two-tiered eurozone where some avoid the worst repercussions of the breakup and some take it right on the nose.

Some Items at Play: Where to draw the line on the breakup and how clean the break are the biggest issues in this murky scenario. For instance, would the breakup be precipitated by popular uprisings, such as Irish voters blocking austerity at the ballot box and thus opting out of the eurozone? Or would politicos be the ones throwing in the towel, or pushing peers out of the EU club? Would the “new” eurozone be formed in one fell swoop, or would “old” states slowly drop out over time?

Variations: The variations are numerous based on which states leaves the eurozone and how they leave. This process could happen over years, or it could happen by 2013. One strange derivative of this partial breakup includes a two-tiered system for the eurozone, where the “strong” states are part of one group and the “weak” states are part of another. Maybe there would even be two separate currencies — kind of a minor euro and a major euro.

Benefits: The “strong” nations in the eurozone, such as Germany and France, reap all the benefits here. They no longer have to bankroll their weaker brethren, they would restore confidence in their banking system and their single currency would be strengthened now that the ne’er-do-wells are no longer allowed to trade euros. The weaker countries will suffer, to be sure, but at least the cancer is cut out and the EU will survive.

Risks: There is a risk that this will not be an orderly breakup; that weaker countries will drop out one by one as Greeks empty their bank accounts, or there’s an outright failure of national governments as voters rise up against bone-deep spending cuts. Worst-case scenario is a crippled eurozone of just France, Greece, Finland and Austria in a rather anemic “union.” And of course, let’s not forget that a partial breakup — especially one that happens slowly and painfully — will only make fear and uncertainty stronger. Such an event would prove not only that the old eurozone is dead, but there is no “new” order with which to forge ahead.

Scenario 3: The Eurozone Unravels Completely

General Result: All parties stop banging their heads up against the collective wall and decide there is no solution comprehensive enough or palatable enough to save the eurozone. Thus, the joint currency that first began circulating in 2002 dies after only a decade of use. Aside from political treaties that are available to all nations, the countries of Europe are on their own once more.

Some Items at Play: The biggest factor here is how self-aware the nations of Europe are if and when insurmountable obstacles present themselves. If the voters of EU member states cannot be convinced or recalcitrant politicians hold up the works, then the eurozone nations need to figure out in a hurry whether it makes sense to keep fighting to maintain the eurozone.

Variations: In short, if an all-out “divorce” happens, the only options are a voluntary breakup that happens in a reasonably quick and orderly fashion, or a meltdown that is a slow and chaotic ordeal.

Benefits: It’s hard to imagine that the breakup of the eurozone would be “good.” But if the move is orderly, at least the pain would be short-lived as member states all reissue their own currencies and we quickly see a divergence between stronger and weaker states. And, of course, the uncertainty would end. Yes, investors’ worst fears were realized — but hey, at least there’s no more wondering about the death of the euro anymore. We can all get on with our lives.

Risks: The risks to the weak EU states are clear, since leaving Greece or Spain to fend for themselves means essentially throwing them to the wolves. But there also are risks to stronger states like Germany. A few months ago, some economists estimated Germany would see its exports collapse by as much as 25% if it were no longer part of the currency union and benefiting from its trade ties. And then, of course, there’s the Armageddon scenario of a chaotic breakup to the euro where there are runs on banks and utter confusion over how to denominate debts. German banks would see huge writedowns to obligations in other nations and lending could freeze up. Not a pretty picture.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace??.com or follow him on Twitter via @JeffReevesIP.

Article printed from InvestorPlace Media, https://investorplace.com/2012/06/3-final-scenarios-for-the-eurozone-crisis/.

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