17
Jul

Where now for Europe?

July 2012 – Kleinworth Benson Investors have just produced a well balanced article about the ongoing Eurozone crisis. With their permission, the article is re-produced here in full.

Needless to say, the future of the eurozone is a key issue for all investors. We think that there are three main “endgame” scenarios from here, each of which we explain below.

1. “Muddle-through” scenario where the eurozone moves from mini-crisis to mini-crisis, with EU leaders doing just enough at the time of each mini-crisis to avert a fullblown meltdown, but not enough to sort out the crisis once and for all.

In essence, while market conditions and sentiment would be bad from time to time, they would
not get quite bad enough for the German and/or ECB authorities to agree to give up their resistance to extreme measures. Basically this scenario is “more of the same” for the next couple of years.

2. “Major Crisis/Major Response” scenario where the eurozone would experience a crisis which would be significantly more serious than any of the various crises we have seen to date. A badly handled Greek exit from the eurozone could be the cause, or a problem in Italy which leads to it being unable to finance itself in the bond market. Whatever the cause, the result, in this scenario,would be an inability of the peripheral countries to fund themselves in the bond market, large-scale bank runs in weaker economies, and a growing fear of an immediate eurozone breakup.

We believe it is highly likely that faced with the imminent collapse of the eurozone which would probably lead to a global economic recession or indeed depression, the ECB and Germany would abandon their perceived key principles and agree to do “whatever it takes” to save the euro. While this scenario is not welcome, as it involves huge risks and much disruption, it would in the end be quite positive for most risk assets, as it would “solve” the eurozone problems in a way that the “muddle-through” scenario would not. In this scenario, ‘safe haven’ assets such as core eurozone bonds will be the big losers.

3. “Meltdown” scenario where policy makers get it wrong, holding to their principles at all costs, and thus allow the eurozone to break up entirely. A global recession or depression would result. Because the consequences of this scenario are so bleak, and so obvious to policymakers, that we believe it is very unlikely to be allowed to happen. From a German perspective, for example, while the costs of rescuing other eurozone countries might be very large, the costs of NOT rescuing them could be much higher. We attribute a probability of only 5% to this “meltdown” scenario happening.

Bringing all this together, Europe is going through a period of historical change, and such massive change is rarely achieved without disruption and difficulty. We have a strong view that the euro will survive this period of disruption, but obviously it will be key to monitor these issues in the months ahead.

Source – Kleinworth Benson Investors.

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