Bullish on the Eurozone (Mostly)

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by Martin Hutchinson, Global Investing Strategist, Money Morning

Last week’s news that Eurozone GDP declined by 0.3% in the fourth quarter of 2011 set all the usual pundits moaning about the inevitable decline of Europe.  Even Andrew Roberts, a wonderful historian with whom I almost always agree, wrote in the Financial Times that “Europe’s fire has gone out.”

This week, the markets may welcome the Greek bailout deal, but behind the scenes they still dread the fact it won’t work.  Meanwhile, hushed whispers are still being muttered about a Greek default as being “worse than Lehman.”

On this subject I am a firm contrarian.

If Greece does default and is thrown out of the Eurozone, then I think Europe is actually due for a rebound – not a collapse.  It’s only if they decide to bail out Greece again that I would become less optimistic.  If that is the case, they would be devoting hundreds of billions of taxpayer dollars (or euros, as it were) to propping up an inevitable failure. Even then, Greece is relatively small compared to the growth drivers in the Eurozone, which are strong.

The Problem with the Greek Bailout

What the Greek crisis has shown is that European leaders in Germany and Scandinavia have their heads properly screwed on, but they are not yet a majority of EU opinion.  The EU bureaucracy simply gave in far too easily to Greece’s first demand for a bailout, then suggested further bailouts for the entire Mediterranean littoral, all of which had over-expanded their governments on the back of low interest rates in the first decade of the euro.  Now reality is returning rapidly to the discussion.

The second Greek bailout, for another 130 billion euros ($175 billion) has passed by the skin of its teeth in the face of strong opposition.  It’s becoming increasingly obvious that a second bailout would be more money down the rat hole, since Greece is quite incapable of re-balancing her economy while remaining within the Eurozone.

This is not a criticism of the feebleness and corruption of Greek politicians, feeble and corrupt though they be.

Greece’s standard of living had simply risen too far for any reasonable amount of deflation within the euro to bring it back to its proper level – about $15,000 per capita, compared with the $32,000 it reached in 2008.  To recover, Greece needs to leave the euro, devalue its new drachma by about two-thirds, and recover an export and tourism sector that would quickly re-employ its people, albeit at much lower living standards than they enjoyed in the fat years.

The EU’s economic models may say that Greece can recover with five years of 30% unemployment, but in practice this would destroy Greece’s society and its people.

So it won’t happen.

Devaluation is the reality, and more and more of Europe’s movers and shakers are coming to realize this.  Even if this bailout finally goes into effect, Greece will be back for more money within a year, and at that point the answer must surely be a firm “No.”

A Greek devaluation would stanch the flow of money down the “bailout” rathole and thereby relieve the Eurozone of a huge cost. The remainder of southern Europe would then redouble its efforts to recover, since the alternative of lower living standards would be so unpleasant.

The Eurozone Recovery

However, whether or not Greece is “bailed out” again, Italy, Spain and Portugal didn’t allow their living standards to get so hopelessly out of whack as Greece’s, so they will have a much better chance of recovering by means of austerity alone without leaving the Eurozone.  Also, last year both Spain and Portugal elected center-right governments, which should be able to eliminate much of the excess spending of their socialist predecessors.

So whether or not Greece leaves the euro, with Italy, Portugal and Spain finally taking an ax to their bloated public sectors, the Eurozone’s prospects actually look good.

Here’s why.

The Eurozone’s monetary policy has been less irresponsible than that of the United States. The ECB policy rate is 1% rather than Federal Reserve Chairman Ben Bernanke’s zero.  All the major EU countries have made major steps on reducing their budget deficits, while Germany and Scandinavia never had allowed the foolish “stimulus” mania to destabilize them. EU regulation is burdensome, but no more so than the stream of regulations coming out of the Obama Administration in areas such as the environment and financial services.

That’s why Europe deserves a modest percentage of your investment dollars.

Germany in particular achieved 3% growth in 2011 and, contrary to expectations, is recovering from a late 2011 slowdown. The IFO index of business confidence rose in January for the third successive month.  Unlike in other countries, German growth is being achieved by supplying goods the world wants to buy. In 2011 Germany’s surplus was 5.2% of GDP, far larger than that of China. With the world economy still in recovery mode, Germany’s prospects for 2012 are thus excellent.

You can take advantage of Europe’s better prospects — and Germany’s in particular — through the iShares MSCI Germany Index Fund (NYSE: EWG).   With a moderate P/E ratio of 11 and a dividend yield of 3.17%, and annual expenses of only 0.51% of assets, this offers a low-cost, liquid way of tapping into Germany’s superior growth.

Put a little in now. But if the Greek bailout collapses, the markets will panic for a few days.

That would be the time to make a really serious investment…

Europe is not as bad as the pundits make it out to be.

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