European Resolution: The 2 Options Available

Includes: EU, FXE
by: Nick Pollari

Europe has arrived at a crossroad where only a binary outcome exists. Italian bond yields continue to soar, Spain just refinanced at record high interest rates, France yields are on the rise, and the spread between German bonds and every other country in the Eurozone continues to grow. This in itself is a little confusing considering that Germany is on the verge of entering a recession. I suppose it is the cleanest dirty shirt in the hamper. At this juncture the two choices for Europe are either: print Euros and recapitalize across the board (the ECB-IMF lending idea is essentially the same idea) or continue to press politicians and governments to make reforms.

The first outcome of the ECB essentially printing Euros is the most positive move for global markets. By the ECB allowing the printing of Euros to purchase debt of sovereign nations their respective yields will decrease dramatically allowing those defunct governments to refinance at much lower rates. Several problems exist in this idea in that the concept of "Moral Hazard" becomes a potential reality, the Euro diminishes in value, and in theory inflation becomes rampant (potentially, we haven't seen much of it stateside). These are only a few problems, but in our opinion represent the most influential issues.

To this day, I still do not understand why this option has not been enacted on a much larger scale. Economic theory tells us that as their exports become cheaper via a cheaper currency, demand increases for those products. Essentially, this helps to solve the problem that is currently frothing at the mouth of most investment professionals, "Even if these countries are bailed out, with no GDP, what is the point? It is a vicious cycle." In contrast, this expands the balance sheet of the ECB exponentially, but the fact remains: does it really matter how big the Fed is? I don't think it matters at all in fact.

The second potential outcome from this event is that the ECB remains steadfast (like fools) and tries to force governments to move faster then markets. That concept is inherently flawed since the markets are discount mechanisms and price things based on future or expected results and not on the present situations. Also, an enormous flaw in this idea is that Europe lacks complete fiscal unity. Without the ECB having the ability to intervene in a country's budget (what Merkel wants currently) there is no chance of having some sort of European fiscal unity. Fiscal unity would mean everyone in Europe follows a single culture on spending and saving and that is completely absurd to assume to be possible or even plausible.

In our opinion, these are the only two options available to the ECB (unless our Fed gets involved, then the options expand) and IMF for a resolution to Europe. One big issue most people are missing is that yields will always continue to rise since no one has any incentive to hold on to the debt. This vicious cycle cannot be broken so long as the ECB wants to "just buy a few" bonds to keep yields attainable while politicians debate and pass plans.

One variable that continues to tick by every day is time. Time is a limited asset and as politicians use this time arguing and debating the moment when sovereign nations will need to refinance their debt ticks ever closer.

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