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Opportunity in Europe's Turmoil

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May 11, 2012 – Comments (0)

Board: Macro Economics

Author: lobodoug

There is a lot of opinion in this thread on issues that are unknowable, despite the "all-knowing" statements. I will attempt to avoid giving my opinion on economic theory, and stick to likely responses in Europe and what they mean to us as investors.

What are Europe's options?

1) Austerity (self-imposed). I think we are in agreement that this one is currently off the table. Unavoidable austerity might not be, though.

2) Germany saves everyone. Yeah, right. Forget that one too.

3) Print Money. This is the option being ignored. These countries, as we all have noted, do not have their own currency so can not print their way out of the mess. BUT, the Eurozone as a whole CAN print. Thus, this is the likely solution. THIS, in my opinion, is what we should be discussing.

I think the European Central Bank will become the primary buyer of European country debt. They are currently forbidden to buy direct. No problem: they offer the banks (who need money badly, and will certainly do whatever is required to keep the debt they already hold from being defaulted on) the chance to buy at 2% and sell the next day at 2.1% Easy money for them for holding overnight. Germany will throw tantrums and insist on debt limits that will possibly be ignored same as previous ones have been. Can this work? Well, it seems to be in Japan and the US. Can it work indefinitely? I honestly do not know.... I am inclined to doubt it, as smoke and mirror stuff usually fails as soon as a light breeze blows the smoke away.... It could, however, kick the can down the road long enough to allow something else to take hold and bear fruit.... But the orchards are looking pretty slim. Where will the new fruit (and shoots) come from?

Other impacts: I think most will figure this will cause inflation, primary through devaluing their currency. What else will occur? Thoughts, anyone?

Other factors: There has to be a re-balancing within the Euro-zone, or the problems will not go away: pay rates in the PIIGS has to come down against Northern Europe. So, even without "austerity", there will have to be some austerity (but it will not be called that...."Hardship" maybe?).

I think this outcome has a far higher than even chance of working out (exact mechanics might vary, but the idea is the same: print money to buy the debt of member nations). Do you agree? If not, what other scenarios do you see playing out? This is, of course, more or less the strategy that the US is taking. It seems to be working in the short-run, as our economy is looking much better than Europe's...this will no doubt be noted by Spain, Italy, et. al.

If, indeed, this is the likeliest outcome, how do we invest for it? My ideas have been tossed out before: I think the European markets are offering some attractive valuations at the moment, although they are likely to get even better in the months ahead. Even the German market is priced at a P/E of around 10 with a 4% yield. Look for buying ops for solid European companies. Any weakness in their currency should help them with international competition.

IF this indeed plays out, then European bonds that are marginal (Greece is beyond marginal....maybe Spain and Italy?) should prove very good....just be aware that Jon Corzine lost a little money betting on Europe backing the bonds enough for them to recover....don't bet the farm (or someone else's farm)! I think it is too early for such a bet...but the time might come.

Currency winners: Australia: if Europe throws Austerity in the trash and goes another route, the economy will either temporarily recover (if you are Austrian school) or perhaps make a real recovery (if you are Keynsian). This will boost China's economy, and thus sales of minerals, and thus Australia. Yuan: getting to be a no-brainer going forward. The benefits of China keeping their currency undervalued are rapidly going away. US Dollar? Depends on how well we manage our own mess!

OK, those are my thoughts. Anything that appears to indicate faith in one economic dogma over another is purely accidental.

Cheers,

Doug

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