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Sept. 14, 2011, 12:00 a.m. EDT
By Matthew Lynn
LONDON (MarketWatch) "” Even a few weeks ago, most analysts would have argued that the euro could struggle on for a few more years yet.
There was plenty of ammunition left in the armory. Moving to a common fiscal policy, and jointly issued eurobonds, would help out the weaker members of the single currency. A massive dose of quantitative easing from the European Central Bank would lift the continent out of depression. Sure, neither would be a long-term solution. But they would keep the show on the road.
This week, even a temporary fix looks increasingly unlikely. The German constitutional court has tied up its government in knots, making it hard to authorize more bailouts. The resignation of Juergen Stark from the ECB has made clear the Bundesbank's opposition to printing money "” and the ECB can't do anything without the agreement of national central banks. And the Greek economy is disappearing down a deflationary plughole, proving that the rescue packages for the peripheral states are a complete failure.
The euro is getting hammered as Greece appears to spiral toward default, but some brave souls insist that U.S. growth and debt fears will soon bite back, pushing the common currency back up again.
The upshot? A disorderly, catastrophic collapse of the euro /quotes/zigman/4867933/sampled EURUSD +0.5733% now seems close to inevitable. If that happens, just about every class of asset will get hammered "” with the possible, but not inevitable, exception of gold.
But it will also open up one of the great buying opportunities of our lifetimes. European shares will be dirt cheap, even though many of them are in terrific fundamental shape.
What investors need to do is get themselves ready to strike when the moment is right.
The news from Europe just gets worse and worse with every day that passes. Even the most pessimistic observers of the euro "” and I count myself among the gloomiest "” generally reckoned it could hold together for a few years yet. After all, there were still moves that could be made to salvage the currency. It didn't make much sense for it to be allowed to collapse without a fight.
Right now, however, that seems to be what is happening.
First, the German constitutional court placed severe restrictions on that country's participation in any more bailouts. It did not rule them illegal, as some people hoped that it would. But it subjected them to approval by the German Parliament. And, in truth, that is as good as making them illegal. German public opinion is implacably opposed to rescuing Greece or Portugal or Italy. The only way it could be done was if the political elite slipped it through in secret. If lawmakers are worrying about their electors, it won't happen.
Next, the resignation of Stark from the ECB last Friday has laid bare the arguments that are raging within the ECB. So far as the markets are concerned, there are two important points. First, it is obvious that the Bundesbank is opposed to buying up any more debt from the peripheral countries. The second is that the ECB is not a central bank like the Federal Reserve or the Bank of England. It is a collection of national banks. If it intervenes in the market to buy bonds, the actual buying is done by the national banks. The Bundesbank has been reluctant to buy peripheral debt in the past "” and it doesn't have to take orders from anyone. Will it do so in the future? You wouldn't want to count on it.
Finally, the total failure of the rescue package for Greece agreed last year is becoming painfully obvious by the day. The Greek economy is now estimated to contract by another 5.6% this year. On the latest quarterly figures it is contracting more than 7%. It is now 16% smaller than it was three years ago. Between 1929 and 1933, U.S. gross domestic product contracted by around 30% "” Greece is not quite in Great Depression territory yet, but it is getting into the same ballpark.
As the economy shrinks, the government inevitably keeps missing its deficit targets. In response, the European Union and the International Monetary Fund demand yet more austerity, pushing the economy deeper into recession. If there was any hope of the current plan working, the economy should be at least stabilizing by now. Instead, it is disappearing into a deflationary death spiral. As it gets worse, the incentive for Greece to get out of the euro grows and grows.
Global Dow
Investors need to hang onto their hats. Just about every class of asset is going to get hit if the euro starts to fragment. The banks will be in big trouble. In France, and Germany most obviously, but elsewhere as well. Vast quantities of credit default swaps have been sold against the possibility of Greece, Portugal and the rest reneging on their debts. Where will all those losses end up? No one really knows. But you wouldn't want to be holding many equities while the markets calmly try to figure out who is going to end up holding the losses.
It won't just be European equities that get punished. Markets across the world will tumble. German government bonds won't be safe, even though investors are fleeing to them for now. U.S. Treasury bonds might survive, as might emerging market bonds. And gold should hold up well "” although it is worth noting that the gold price fell by 10% after the collapse of Lehman Brothers. But that will be about it.
The few weeks after the euro collapses, however, will be one of the greatest buying opportunities of our lifetimes. Shares prices will overreact massively, and sink well below their 2008 lows.
But the euro zone has plenty of great, global companies "” big, successful businesses that sell their products right around the world. Economies such as Italy haven't grown for a decade. Liberated from the euro they will start to motor again. Countries bounce back fast once they are liberated from dysfunctional monetary systems "” and equity prices bounce back even faster.
That moment is getting closer all the time "” we may well see it within the next twelve months, and possibly before the end of this year. But until the euro crisis is resolved, every kind of equity market is best avoided.
Matthew Lynn is a financial journalist based in London. He is the author of "Bust: Greece, the Euro and the Sovereign Debt Crisis," and he writes adventure thrillers under the name Matt Lynn.
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