European Debt: Why Bailouts Won't Work and the Euro Will Fall
Ireland is the focal point of Europe's rolling debt crisis, the next stop on the tour that began in Greece, with Portugal, Spain or Italy due up soon (at least the officials who negotiate the next bailout will benefit from better food, wine and weather). A recent opinion piece in the Financial Times by Komal Sri-Kumar, chief global strategist at TCW Group, highlights the futility of Europe's financial bucket brigade and its serial rescue missions and offers lessons for investors.
Sri-Kumar contends that Europe's crisis resembles the one in the 1980s in Latin America. Foreign entities like the International Monetary Fund imposed austerity measures on Latin American governments, exacerbating problems by choking off growth and leaving authorities with even less money to repay debt. The same thing is happening in Europe, he said, and he warned that the crisis will persist until a similar solution - a massive debt workout with creditors agreeing to substantial write-downs on their loans - is implemented:
"The Latin American crisis was a solvency issue rather than a liquidity issue. A significant portion of the loans the nations received in the 1970s was used to finance wasteful consumption, or eventually landed in Miami- and New York-based banks due to capital flight. They were no longer available to service debt. We also learned that these countries could not generate sustainable economic growth, or create jobs, until the debt levels were reduced. Both these conclusions are relevant to resolving problems that southern Europe and Ireland face today, and call for a similar program to reduce the level of debt."
Sounds like a perfectly reasonable solution for Europe, so don't bet on it. You might even consider betting against it and assuming that the region will continue to have the economic life sucked out of it. Discussing his ideas with MoneyWatch, Sri-Kumar suggested ways to place a wager on the uncomfortable and unhelpful status quo.
"Euro zone companies serving regional customers - utilities, domestic transportation companies, consumer items - will be at a disadvantage compared with euro zone companies that can take advantage of greater foreign opportunities stemming from a weaker euro. In country terms, I think Germany and France will lead the winners due to increased foreign trade opportunities, with Greece and Italy being at the bottom."
Buying one of the exchange-traded funds that rise in value when the euro declines is another idea he mentioned. PowerShares offers a fund (UUP) that tracks movements in the dollar against a basket of currencies, and ProShares and Market Vectors have funds (EUO and DRR) that are leveraged plays against the euro; for each 1 percent daily rise in the euro, the funds are designed to decline 2 percent and vice versa.
Just remember, double the move means double the chance of loss, so the leveraged funds are only right for speculators with a great tolerance for risk. It's always possible, though highly unlikely, that European leaders will take the right steps and solve their debt woes once and for all.
