European Debt Crisis: Continuous Bailout Is Not The Answer

Includes: DIA, ERO, EU, QQQ, SPY
by: Francis Ayensu

Should we look out for a deep global recession or just consider these recent market downturns as yet another market slowdown? This is the question I have been asking myself these few weeks. The news is dominated with economic woes in the most advanced economies. Europe is having a hard time dealing with its debt crisis while the US is still fighting economic recession.

Where is the global economy heading towards in the near future? Should Greece default and Europe let the chips fall where they may? The consequences would be highly contagious and a huge blow to the euro. How would the EU react to such a situation? Is the current response of another bailout the right solution or maybe Greece should be allowed to exit the euro and thus the consequences would be minimized? The EU is probably facing its biggest challenge since its creation. Political interests seem to dominate economic interests. German chancellor Angela Merkel and French President Nicolas Sarkozy are more keen on saving the euro and keeping the EU together.

My perspective on the European debt crisis is that economic problems should be addressed from an economic point of view and should not be clouded by political considerations. The problem with the EU is that weaker nations still pose a threat to the union at least on economic issues. The question EU leaders have been avoiding is- Is the eurozone better off with or without these debt threat members?

Economic theory suggests that economic integration creates more wealth for the regional zone than in the case of combined wealth of individual economic units on their own. Maybe hte EU is the exception as weak economic units pose a threat to the union. Having seen the fruitless outcome of bailout and austerity measures, the eurozone would be much stronger if these debt threat members are allowed to withdraw from the zone, perhaps temporarily if not permanently.

Continuous bailout of these debt threat nations is not a lasting solution and would definitely lead the EU into more debt. The EU would take a longer time to recover from the global financial crisis if it sticks to its policy of bailout. The EU leaders would have to adopt other measures to come to the rescue of its debt threat members. A restructuring plan for these weaker economies outside the euro should be considered by the EU leaders. Such economic measures would bring more flexibility in turning the economy around and would allow the weak economies from to comply with bailout requirements and to meet budget cuts without external pressures.

The debt threat nations-Greece, Italy, Ireland, Portugal, and Spain- all together contribute 25.82% to the total GDP of the EU. The macroeconomic indicators of these economies are: unemployment rate is highest for Spain at 21.2%, next is Greece at 16.7%, followed by Ireland at 14.6%, then Portugal at 12.3%, and finally Italy, which performed well with respect to the others, at 7.9%. The unemployment rate for the overall eurozone is currently at 9.5%. Spain's public debt (60.1% of GDP in 2010) is significantly lower than that of Greece (142.8%), Italy (119%), Portugal (93%), Ireland (96.2%), and Germany (83.2%), France (81.7%) and the United Kingdom (80.0%).

Investing during these volatile times is quite daunting. The markets are more likely to be down than up. So investors would have to focus on the downturn if they want to outperform the market. The best trading strategy is being short on the major market indexes such as S&P 500, DJIA, FSTE 100, DAX, and CAC40 and hedging risk positions with commodities derivatives such as gold and oil.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.