The Eurozone sovereign debt crisis have now more than two years old and still counting, with an ultimate solution not foreseeable in the near future. The increased uncertainty due to recent Greek elections and the impossibility to form a government just added more fuel to the fire, but can possibly trigger the final outcome for this crisis.
The sovereign crisis has shown that the European Monetary Union has structural flaws that remain to be fully addressed. Although some steps have been taken, none completely solved its key problems. Given this, the four scenarios which seem most likely to result in a step forward to the resolution of this European soap opera are:
Peripheral Exit: Greece is obviously the first candidate to exit, but if Greece indeed leaves the Eurozone is it possible to stop the contagion to Portugal, Ireland, Spain or Italy? Probably not, and a Greek exit wouldn't be the end of the crisis as several issues would still be unresolved, such as a joint baking system guarantee or the possibility of debt monetization by the ECB.
Core European Union: This would represent a step back in the integration process in Europe, with Germany leading a few ((CORE() countries within a "mini-Eurozone". The weaker members would leave the monetary union and devalue their currencies to remain competitive, something impossible to do currently. As an export-machine Germany itself strongly benefit to be part of the Eurozone, so the political will for this scenario is extremely low.
Fiscal Union: The likelihood of a move to fiscal union is small in the near term, as the political will for it does not exist currently. This step would require a loss of sovereignty and the joint issue of bonds (Eurobonds), with Europe converging to a "United States of Europe". For more in-depth analysis see my previous article "Europe needs to work towards fiscal union".
Full Break Up: With all this fatigue of austerity in southern European countries and more need for economic growth policies as shown recently in Greek and French elections, this can lead to a full break-up of the Euro and, consequently, of the Eurozone. As I discussed on "Why the French and Greek elections are bearish for the Euro" the Euro is a political currency, and if the political leaders start to disagree on the road to recovery this increases a euro breakup scenario. The probability of this scenario increased markedly since the beginning of May but it seems to be the worst-case scenario.
Conclusion
Eurozone policymakers have been slow introducing additional measures to resolve the crisis, often only in response to heightened market pressure. Although other outcomes are possible than the previous four scenarios, they represent the most likely solutions at least in the short to medium term.
With the current market's spotlight turned to Spain, which may be to big to bailout given its financial system woes, and the very real possibility of a Greek exit, European policymaker's can "sell" to their electorate the idea that a deeper integration is required to avoid the demise of the euro. I think this is only possible with fiscal union, and is the most probable route for European policymakers to follow in the medium to long term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
