Bailout 2.0: What Even More Austerity Means For The Euro Zone (EWG, VGK, EUO, EPV, IEV)

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March 2, 2012 3:24pm NYSE:EUO NYSE:EWG

Monty Agarwal:  A 10-page document prepared by analysts in the so-called “troika” of international lenders (the European Central Bank, European Commission and International Monetary Fund) — marked “strictly confidential” and dated Feb. 15 — was meant for only the top brass of the troika.

But somehow it got leaked.

Not surprisingly, the outlook for Greece achieving a meaningful recovery is lukewarm at best. But that’s not coming from economists and traders and the media. That’s the sentiment of the very people who are charged with helping to pull the country out of its debt spiral!

As we’ve seen, the markets fly or flounder based on the headlines of the day, and the euro-zone crisis has impacted the global markets for well over a year.

Even if the Greek economy starts growing again in 2014 as expected under the careful watch of the euro zone, there’s a lot that can happen in the meantime. Which begs the question …

Greek Bailout 2.0 – Here We Go Again?

On Monday, the German (NYSEArcA:EWG) parliament approved a second bailout package for Greece to the tune of $173 billion (U.S.). Although the prospect of this loan approval — and the deep cuts in wages and jobs themselves that are part of the hefty price tag — created a great deal of dissent (and spurred tens of thousands of citizens to publicly protest), the package passed by 496 to 90 votes.

Next up this week are votes in Finland and the Netherlands, where the Washington Post notes that approval of the aid package “isn’t expected to face problems in either country.” This means that any hurdle would be entirely unexpected and, thus, would be cause for concern.

The problem isn’t necessarily getting the bailout (the second in two years) to pass. According to the leaked document, the concern is whether Greece will slip into such a deep recession that it will need yet another round of funding after this three-year loan period.

This confidential “debt sustainability” report is filled with such extremely interesting data that it has been hidden from the public so far, but here are some of the highlights:

  • Given the high prospective level and share of senior debt, Greece’s ability to return to the market in the years following the end of the new program is uncertain and requires more analysis.
  • “Prolonged financial support on appropriate terms by the official sector may be necessary.” In other words, the second bailout likely won’t be the last.
  • The next sentence is where things get really dire. The analysis suggests that the medicine being fed to Greece — trying to drive down wages and costs through austerity measures to make the Greek economy more competitive internationally — will lead to higher debt levels in the near term that may never be overcome. The projected debt-to-GDP ratio for Greece is as high as 160% of GDP in 2020.

The CNN article notes the possibility that the severe cuts (i.e., austerity) could cause debt to skyrocket further and that this “debt restructuring could prevent Greece from ever returning to the financial markets by scaring off future private investors.”

Austerity aside, the Private Sector Initiative (PSI) means more than just the public sector is also feeling the pain. This “rescue” also means private-sector investors accepting 50% or more (in some cases, much more) in bond losses.

Now here is the really shocking part …

Even though the members  of the bailout committee know the truth behind Greece’s woes, they are telling  the public things that are completely different — i.e., “lying to their faces.”  This is because, on Feb. 21, the troika passed the bailout package for Greece  and made absolutely no mention of their concerns.

But we know the truth  behind what the true situation in Europe looks like. And clearly so does  Interior Minister Hans-Peter Friedrich, who — right before Germany’s vote — called  for Greece to voluntarily leave the euro zone. German Chancellor Angela Merkel  publicly rebuked Friedrich’s comments and cautioned against the risk of  allowing Greece to go bankrupt.

According to Merkel, the  opportunities here outweigh the risks. While there may be some truth to that  statement, the risks are pretty massive as well … particularly to the value of their  shared currency.

What Even More Austerity Means for the Euro Zone

The path of austerity  adopted by the European governments – which involves the sale of assets, public  sector reforms and increased participation by the private sector – essentially  contains long-term solutions that will take years to play out.

As the governments in  Europe (NYSEArca:IEV) adopt severe austerity measures, we’re witnessing shrinking GDPs across  the European continent. This growth reduction will affect corporate earnings,  which will translate into lower stock prices. There is no way around this,  unless the European Central Bank decides to stimulate growth by printing euros  and thus devaluing the single currency on a large scale.

Therefore, if the ECB  continues with its band-aid measures and stiff fiscal austerity, we will see the European (NYSEArca:VGK) stock markets correct by 20% to 25% in 2012. Conversely, if the  ECB realizes that the only short-term solution to Europe’s growth and fiscal  issues is to print more euros and thereby devalue the currency, then we could  easily see the euro head to parity against the U.S. dollar.

This is further evidence of why I’m short Europe (NYSEArca:EPV) right now, and why you should consider taking a bearish stance on that area as well. [Related: ProShares UltraShort Euro ETF (NYSEArca:EUO)]


Written By Monty Agarwal From Money And Markets

Money and Markets (MaM)is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaMare based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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