May 23, 2012

Euro Resolution Likely, but Will Be Messy

After spending a week in Europe talking to scores of investors, it’s obvious that the Greek crisis has reached an inflection point. I’m convinced that the most likely resolution is one that, in the eyes of Germany, solved the most issues for the lowest cost. That is why I think the issuance of euro bonds is the high probability outcome.

Think about it: Germany found a way to artificially depreciate its currency by joining the eurozone, which made it more competitive in global trade. 

Now the music’s stopped. With no solvent trading partners left in Europe, it’s likely that the breakup of the eurozone—or the departure of Greece, along with the second-order risks of other countries leaving—is more expensive than simply bundling up everyone’s balance sheets and issuing euro bonds. 

Germany wasn’t the only beneficiary of eurozone synergy. The other member countries strapped onto Germany’s solid balance sheet and were able to borrow at lower rates than before. But if euro bonds are issued, there has to be a mechanism in place to punish member states that aren’t fiscally responsible.

I’m not sure what that mechanism will be. It could be a central treasury, but that seems extreme. At any rate, the path of resolution will likely be extremely rocky. Afterward, Europe equities could be a screaming buy—but for now, I’d keep some dry powder.

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