Euro Panic: What Investors Should Do

Back in 2003, my wife accidentally let a trivial $300 medical bill go unpaid. It wasn’t disputed, the hospital just never bothered to send her the bill. And for the next seven years, we thought nothing of it.

Two months ago we bought a house, and that unpaid tab came back to haunt us. While my credit scores are great, lenders look at the weakest link in the chain — and her lower FICO bumped our interest rate up by 1/8 of a point. In short, that $300 oversight could end up costing us thousands.

The point is, marriage represents an economic union where we are held accountable for the actions of our spouses. In Europe, Germany is a polygamist married to 15 other European countries. No wonder it wanted a pre-nup before ditching its bachelor days with the deutschemark and saying “I do” to the euro.

According to The Economist, more than 150 of Germany’s top economic minds recommended against joining the euro until other member states took a stand against deficits and tackled their debt. Otherwise, Germany would be the glue that had to hold the whole thing together.

That was back in 1999. Today, they are undoubtedly saying “Ich habe es lhnen gesagt” — I told you so.

In recent months, the structural imbalances in the euro have become painfully obvious. In fact, I decided to short the CurrencyShares Euro Trust (NYSE: FXE) in my ETF Authority newsletter this past March. Confidence in the common European currency has completely unraveled since then.

The unnerving -1,000 point plunge in the Dow last Thursday may have been exacerbated by technical glitches, but it was fallout from Greece that had traders on edge to begin with. Leaders in Athens had rammed through some stringent austerity measures to appear more creditworthy. But as I pointed out to my readers, Spain and other neighbors throwing out the financial lifeline are themselves in danger of foundering.

I predicted further intervention by the International Monetary Fund (IMF) and it came just four days later when European leaders cobbled together a $1 trillion rescue package. Under the agreement (which is aimed at stabilizing the euro), the 16 members will raise $572 billion, and the IMF has pledged another $325 billion — a huge line of emergency credit to extend to cash-strapped countries buried under stacks of bills.

Apparently, European leaders finally reached a very American conclusion: actions speak louder than words. The knee-jerk reaction in the debt, equity and currency markets was one of relief. The euro bounced back above $1.30, bond yields fell and stocks from Paris to Frankfurt jumped.

Before the ink on the deal was even dry, though, many investors hastened to point out that you don’t give an alcoholic a stiff drink — or in this case, shopaholics a shiny new credit card. Once the ramifications sank in, the excitement died down quickly. In fact, the euro relinquished its gain and is now back where it was before the deal was announced.

Some aspects of the package are at least mildly reassuring. The European Central Bank has made the controversial decision to buy sovereign bonds issued by debt-riddled countries, essentially backstopping their credit. This should please institutional investors, while allowing the PIIGS (Portugal, Ireland, Italy, Greece and Spain) time to lose some weight.

Unfortunately, it does nothing to address the blatant fiscal irresponsibility that caused all this. Member states are supposed to limit their deficits to a manageable 3% of GDP. But this rule has been universally ignored — I’ve seen more teeth on United Nations sanctions.

Until these profligate countries learn to live within their means and plug budget gaps (are you paying attention Washington?), bailouts just reinforce the notion that rampant spending can continue with impunity.

Whether it’s through direct lending or loan guarantees, there’s a big risk in handing blank checks to nations that are already deeply overdrawn. This is a zero sum game — the proposals won’t eliminate a penny of debt, they just shift it from weak countries to stronger ones.

The fact is, Europe’s overreaching socialist agendas can’t be supported when economic output grinds to a halt. Don’t take my word for it. EU President Van Rompuy put it best, “with just +1% growth, we can’t finance our social model anymore.” Unfortunately, there are no easy solutions.

The naysayers insisted that having a unified currency under disparate treasuries and governments would lead to nothing but trouble. They were right. The responsible are now being forced to shoulder the burden for the irresponsible; the competitive are footing the bill for the non-competitive; the productive are carrying the non-productive.

That’s not an easy pill for taxpayers to swallow.

Not surprisingly, many Germans are in favor of abandoning the euro ship — or at least making Greece walk the plank. This complaint brings up a valid point. Should one country that accepted tough sacrifices shell out billions to bail out another that got in over its head? Well, it does if it wants to salvage the euro.

There is talk of establishing centralized taxing and budgetary authorities. I have my doubts — if two political parties from the same land can’t reach a consensus, how will 16 different nations see eye-to-eye about contentious issues like tax policy and the allocation of bond revenue?

For now, Europe will have to do a much better job of policing its financial guidelines. That won’t be easy — just look at the riots in Greece. Plus, they will require public sector wage and pension cuts and harsh tax increases. These “anti-stimulus” measures will do nothing to help the region’s anemic economic growth.

To make matter worse, recent credit downgrades have made it tougher (and costlier) for many European countries to tap the capital markets and borrow money. The debt crisis won’t be cleaned up anytime soon — which means the euro will remain under pressure.

On the flip side, all of this has pushed gold to record prices near $1,240 an ounce. With the euro’s reputation as an alternate reserve currency now tarnished, I suspect governments are unloading some of their holdings in favor of something a bit shinier.

Plan accordingly.