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It's often difficult to comprehend - much less internalize - the risks posed by the European sovereign debt crisis.
But understand this: If Europe's problems aren't resolved in an orderly fashion, the stock market drops we saw last month will be small potatoes compared to the steep declines that lie ahead.
So here's the solution: Let the Eurozone break up right now on its own terms. And let a new, stronger euro currency come as a result.
At this point, that is the only viable solution to the problems Europe faces.
So far, everything the European Union (EU) has done to try to subdue this outbreak has come up short. In spite of all the group's efforts, the European sovereign debt crisis continues to snowball, drawing more and more countries into the fold as it gathers momentum.
The trendy solution is to simply expel the weaker members of the Eurozone. That would work if Greece was the only problem, but it's not.
That's why a better solution would actually be the opposite - for the stronger countries to abandon the euro and create their own currency.
European countries with strong economies - Germany, the Netherlands, Finland and Sweden - should simply walk out.
I'd like to take credit for breaking new ground with this idea, but I can't. Former head of the Federation of German Industries, Hans-Olaf Henkel, writing in the Financial Times recently proposed this alternative solution as well.
Still, it's worth subscribing to for a number of reasons.
To begin with, it would absolve the strong countries of their liability to prop up their weak Mediterranean sisters.
It was one thing when only small countries, such as Greece, Ireland and Portugal needed propping up. But now Spain, with a collapsed housing bubble and eight years of bad management, and Italy, with the most debt of any country in the EU, are at risk. Both of those countries' economies are large enough to put a sizeable dent in even Germany's vast wealth.
Even more ominous, storm clouds have started swirling around France, which is still rated AAA but does not deserve to be. The country has not balanced its budget since the early 1970s, and public spending has soared on the back of hopelessly uneconomic schemes such as the 35-hour workweek.
Now the French government has come up with a supposed solution - one that consists entirely of tax increases.
So it's clear now that something must be done. And the solution I support has benefits for both strong and weak Eurozone countries.
The Benefits of Breaking Up
For the stronger countries, leaving the Eurozone voluntarily and forming a new, stronger euro currency would have three immediate advantages.
- First, since a number of countries would be involved, it would be a chunky currency, so speculators would not be able to drive it up to absurd levels and kill off exports.
- It would also allow the strong euro countries to manage their own monetary policy. That would wipe out the inflation threat and ensure that domestic savers were adequately compensated. It also would eliminate any need for bailouts among these countries.
- Finally, it would preserve the advantages of a foreign exchange free zone between these countries, so that transfers would remain cheap, without additional forex costs.
However, there are also benefits for the countries that stick with the euro, which would presumably weaken.
These countries would not incur the stigma of failure that they would by leaving the euro themselves, yet its new weakness would improve their competitiveness. It would push up their economic growth rates and make it easier to bring their governments back into shape.
Their inflation rates and interest rates would be higher, of course, as was the case for the Mediterranean countries before the euro was invented. However, their debts would remain denominated in euros, so they would not suffer the problems of the Asian countries that devalued in 1998 and increased their debt burdens and bankrupted the banks.
Getting Past the European Sovereign Debt Crisis
It's likely that Greece's economy would be too weak to sustain itself even in the weaker euro, so it would have to return to the drachma, and its creditors would have to write off most of their debt. Still, that's a small problem in the context of the EU as a whole.
An EU with two euros, plus peripheral currencies - such as the British pound, the Danish crown and the Polish zloty - would keep much of the benefits of the euro. For the most part there would only be one large foreign exchange market, rather than 17.
However, the two blocs would be much closer to Robert Mundell's "optimal currency zones" than the oversized and unwieldy Eurozone. They also could coordinate fiscal and economic policies with each other, rather than ceding more power to the arrogant and unresponsive European Central Bank in Brussels.
There's a sporting chance that the German Federal Constitutional Court will declare the bailouts of Greece and other countries to be unconstitutional and contrary to the 1993 Maastricht Treaty.
In that case, a new currency bloc will be the only solution to the European sovereign debt crisis. But even without an adverse court decision, it represents a more attractive alternative to endless bailouts of the feckless laggards.
There are, of course, several ways for investors to prepare for the Eurozone's inevitable disintegration.
Right now exchange-traded funds (ETFs) represent the best opportunity to profit.
The two best economies are Germany and Sweden, so at the very least you should consider the iShares MSCI Germany Index Fund (NYSE: EWG) and the iShares MSCI Sweden Index Fund (NYSE: EWD).
Sweden is a member of the EU but doesn't use the euro. And Germany's economy will perform even better than it does now if it's ever liberated from the freeloaders it currently carries on its back.
I'm also looking into some specific companies for subscribers to my Merchant Banker Alert. So if you're a member, stay tuned - and if you're not you can learn more by clicking here.
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How to Protect Yourself From the Collapse of Treasury Bonds - Money Morning:
GDP Is a Lie - It's Time for a New Measure of Economic Growth
With your proposed resolution what would happen to the savings deposited in German or Swedish banks for examplr?
Yes, well, all that is fine ….. but doesn't Germany OWE Europe something for it's past history of "taking over"?????? So now you think it is fine if they just walk away and don't support the weaker countries? No, I think not. You know, if THE UNITED KINGDOM hadn't procrastinated about losing their precious GBP in the beginning, THEY would have been the controllers of this whole Euro thing – I mean, the centre of the world's financial balance has always been in London …. but they allowed Brussels …. and now Germany, to be there! So is all this really 'sour grapes'? Whatever …. personally, I think the countries which joined the Euro currency should now HELP and SUPPORT the weaker ones and NOT JUST WALK OUT when things get difficult!
Yes, but what will happen to all those people holding EURO currency and how will a reversal be made now?
The scenario you are exposing here, Martin, sounds pretty desirable. However I have some doubts about European politicians implementing it. May be the German constituional court will speed up things a little.
I am afraid however, that the "good" Euro-countries will have the bear the brunt of the reckless US financial policy. Things on your side of the pond do not look like being any better, just much bigger in as much as funds are involved.
As to the ratings, I agree, France does not deserve a AAA rating, but the US in my opinion are just about good to be downgraded to junk, which in fact it should have been done for quite a while already. However, if you prevent the US from printing money, the whole financial system will collapse straight away – in it eventually will anyway – anything else is just buying time. Very interesting times ahead!
I live in Austria but, due to its infinitisimal size, it is never listed as a candidate for either the strong Euro group or the other. Your opinion?
The successful outcome of such a move would validate the truth of the idea going around the internet that fiscally conservative and relatively solvent areas of the US should split off from those hopelessly entrenched welfare bastions in the US run for decades by "progressives, lunatics and morons." The US of Conservative America would thus be made up of Texas, the South and the rural hinterland, while Liberal America would bask in the swill of Detroit, New York and California. If only it were possible….
Well, to "walk out" you have – in the case of Sweden – to walk in first!
Dear Sirs,
Sweden's currency is swedish crowns(SEK) and not euros!
Kind regards
Leif Wesander
Good pick. This situation is analogous to an alcoholic and an enabler who thinks they can fix the alcoholic. Eventually the enabler is ruined as well as the drunk, because the drunk has no motivation to fix themselves. Drink up Greece and good luck Germany.
I am interested in Martin Hutchinsons 'Merchant Banker Alert'.
I am British and I live in Mexico. When I start playing (if that's the right phrase) what do I have to ensure to be able to make the plays. Will I need proof of ID, address, bank account etc. which isn't a problem, however, I do not wish to get excited and join only to find I am not qualified in some way to get on board the train.
Thanks
Ronald
Just to complete your knowledge… The Uuropean Central Bank is in Frankfurt, not Brussels!
Cheers
re: european debt crises
You are too simplistic!! Banks throughout the stronger countries are loaded with sovreign debt paper of the weak countries. They, the ECB, and the IMF along with the Fed would be in big trouble causing a wave of bankruptcies and concommitant currency freeze debacle! This would spread to retirement funds, ETFs, mutual funds, money market funds, ad finitum!!! We would certainly have a worldwide depresion….
Interesting thought However you failed to address the exposure most German, Dutch and Swedish banks have in countries like Greece, Spain, Portugal and else….Europe is indeed in a mess, but the contamination is such, that it will probably flock together to stay afloat.
That sounds like a great idea! Maybe we could do the same in the U.S. . Any states that are in good shape just bail out. OR EVEN BETTER… All the states just bail on Washington, since that is where the problems are really coming from in our union.
Just like any relationship huh? When poverty walks through the door. Love flies out the window…
Dear Mr Hutchinson,
Thanks for an interesting article, but this is not a new idea, it has been around for a long time, at least since the Maastricht Treaty. The weak countries should never have been accepted into the Euro area in the first place, as the Germans said at the time.
The main objection is of course that it risks breaking up the whole European Union, not only the Euro area. We would get a strong, disciplined, Germanic camp north of the Alps; and a weak, undisciplined and easy-going Latin camp south of the Alps. The two core countries of the Union, France and Germany, would end up in opposite camps. The EU would lose this European "engine" unless France is adopted in the strong Germanic camp. Prestige and face-saving would play a strong role. It would take exceptional diplomatic skills to solve the issue. And LONG TIME.
A few other comments:
*The European Central Bank is of course not in Brussels, but in Frankfurt, Germany.
*Sweden is not in the euro area. But the Swedes might be persuaded to join a strong North European euro. Its public finances are the envy of any euro member, they are even excpected to run a budget SURPLUS this year.
*The Danish Krone is pegged to the euro at a fixed rate of approx 7,45 kroner to 1 EUR. So it is already more in than out of the euro. Public finances are well managed and balanced; that will not be an objection to joining a currency union of strong, disciplined countries north of the Alps.
*You did not mention Austria; but they would certainly belong in the strong North European camp.
*Belgium is a tricky one, they have high public debt. They should probable follow France.
*There remains the question of the string of smaller countries. North of the Alps you have Estonia, Slovakia and Slovenia.
So I guess they will have to find another solution. It is hard to see any European leader with the guts to work for drastic changes. Unfortunately, I think it will end up with Northern Europe subsidising Southern Europe, not only this year, but for many, many years to come.
Regards
Einar Dahl
what a load of rubbish, the dollar will be gone before the euro, invest at your peril.?
And for the PIIGS, this solution:
Southern Europe Financial Zone
1.Portugal, Greece, Spain, Italy and Ireland all leave the Eurozone at once, and default on their loans
2.They establish their own currencies, at once.
3.Each currency is backed by a basket of commodities and vouchers from that country. These commodities would represent the goods and services required by the elderly or poor population such as wheat, olive oil, dairy, wood, bricks, vouchers for routine dental and medical care, and energy. In this fashion, each new currency would actually be backed by commodities such that if there were a run on that currency, it would produce jobs and prosperity.
4.Each country would have a tax rate very favorable to corporations, and a small free port, in the manner of Hong Kong.
5. Travel within the zone is passport required but unlimited tourist visa. Major limits on work permits and residence permits. Assimilation expected. Work permits mostly for folks who start businesses and create jobs.
6. Tax policy is set to reimburse zone corporations for currency transaction expenses within the zone. Even though there are five different currencies, it should be almost expense free to do business in the other zone currencies.
Great reading and insight on the world of investing. Sure wish that I had the funds necessary to get in on the action. Maybe soon! For now I'll keep reading and sharpening my mind on this fantastic newsletter. Keep it up. Raymond.
hi your analysis that the eurozone break into two zones, will surely solve many problems of not
only europe but the rest of the world as well.in light of nostradamus prediction that the new block
would consist of ten nations which will include the uk and usa .with uk and usa in decline a super block of strong economies could bring some stability to the world and trade.only time will tell if this prediction comes true,as a new currency if not the euro.
I am quite sure the danes will wellcome a euro split and join a new common currency. They have never believed in the Brussels based ECB policies. One can not mix greek style "fiscal discipline" with that of the german kind. "The commissars" have failed miserably to keep the fiscal house in order, it is now based on clay feet endangering the economy of the world. It is time to break up!
Im going for gold
Hi
In my modest opinion, a strong currency is not as important as a stable currency; the consequence of Greece ect leaving- will cause the Euro to rise in value, then who will the Germans sells their inflated goods to?
One idea as a solution to the crisis is to treat the national debts like a morgage, the loan being made from the Central European bank, and to be paid back over 25yrs at a rate 3%. This gives every one the time to reorganise and mantain cohesion.
At the same time funds would be raised by the Central Bank by a Europe wide levy of 2% Vat , raising some Euros 100 milion each year. The debts paid off, a fund of some Euros 3 Trillion created to cushion ourselves against the next Economic Shock that will evetually arise.
Thanks for ypu attention
Lino