The Need-to-Know Basics About What’s Going On in Europe

by ETFguide | October 17, 2011 5:30 am

European Stocks[1]Wall Street is dancing to Greece’s (and by extension Europe’s) whistle. If Greece says “jump,” Wall Street jumps. If Greece says, “Sorry, false alarm,” Wall Street cries.

This sorry dance has been going on for nearly two years. Like an endless loop of chicken dance, this might be fun at first (for about two minutes), but it gets old real fast. If you are tired of Wall Street’s chicken dance coverage and want to know what’s really going on and how to make money (or protect your assets), here’s a no nonsense assessment of Europe.

Greece — Fool Me Once …

Fool me once, shame on Greece, fool me twice, shame on me. Greece has been the scapegoat for every major sell-off and catalyst for most rallies and dead cat bounces since January 2010.

Shame on you if you think everything’s going to be hunky-dory just because Greece and/or its European pretend-to-be saviors announce another plan to come up with a plan.

The Problem

Here’s the problem: Greece is broke and has no significant revenue sources to pay off its debt — foreign investors own about $385 billion worth of Greek government debt.

Many banks and governments that own Greek debt are on the brink of insolvency, so Greece’s inability to pay its debt may push other countries and their banks into a Greece-like position (that’s called contagion).

Misleading Information

You can’t trust statements from European officials because they are trying to prevent panic. Panic will make any kind of solutions more expensive and more difficult to execute.

Luxembourg’s Prime Minister (also Chairman of regular euro zone meetings) blatantly admitted that: “When it becomes serious, you have to lie”.

Obviously, political leaders don’t want the euro zone to fall apart on their watch, so they pretend and extend and kick the can down the road far enough for it become someone else’s problem (someone else will inevitably include rosy-eyed investors).

This postpones the inevitable, but the portfolios of investors who are faithful enough to trust such assessments suffer a death of a thousand cuts. Just imagine where your portfolio would be if you sold everything when Greece first announced it had some minor fiscal problems. Like tearing a bandage off a hairy leg, slower is more painful.

You also can’t trust the media because they profit from sensationalist headlines, not sound investment advice. If that means they have to spoon-feed a consistent diet of “Stocks bounce on hopes for a Europe fix” followed by “Stocks plummet on fears over Europe,” then that’s what they’ll do. Fortunately, we can choose not to partake from the junk food dished out by the media.

On a different note, have you noticed how bad news (such as downgrades) is reported after the close (particularly Fridays), while good news (or even just good rumors) are reported while the markets are open?

The (Only?) Plan

Let’s just be realistic and admit that Greece is as good as bankrupt. The country just doesn’t have enough income to pay its debt load and keep the country functioning properly without outside financial support.

Eventually, Greece’s saviors will realize that this is a leaky bucket-like money pit. A sudden and unprepared Greek bankruptcy would shatter the euro zone unless Greece is quarantined first. The goal here would be to sequester ripple effects that would cripple Italy, Belgium, Portugal, Spain and whoever else is hiding in the closet.

Doing this wouldn’t be cheap. To prepare for a such a quarantine (which is a more diplomatic term than ejection) from the euro zone, Europe (via the EFSF) would have to prepare and fund a fund that can pay for:

  1. Defaulting Greek government debt
  2. Shoring up banks that won’t qualify for inter-bank credit
  3. Making sure Italy and the next dominos in line are safe

Statfor Global Intelligence estimates the price tag to be about $3 trillion. The chart below visually explains the above-described process. Can Europe scrape together $3 trillion?

Doomed if You Do, Doomed if You Don’t

I don’t think it matters much, because the above plan doesn’t take into account human emotions — panic in particular. European banks’ deposits at the European Central Bank already have mushroomed. This means one bank already doesn’t trust another bank with their money.

The combination of liquidity drying up and assets imploding is a lethal one, so what about those saying, “Things aren’t that bad”?

Just consider Dexia. Dexia passed the European bank stress test with flying colors but still had to be rescued. Dexia is supposed to be rescued partially by the country of Belgium, but Belgium’s national debt is already 100% of GDP. Depending on Dexia’s actual losses, Belgium’s national debt might soar to 120% of GDP just by having to bail out one bank. Do you know how many banks there are in Europe?

I expect a rocky road in the coming weeks.

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