As we discussed in our Q4-09 Broyhill Letter, it appears that the EU’s initial plan of action (see illustration below) was not exactly a robust plan after all. At the time, we suggested that Mr. Almunnia consult his history books, when he claimed that “There is no bailout problem. In the euro area, default does not exist.” Actually, European nations have defaulted on their debt a stunning 73 times since 1800, with Greece in default more than 50% of the time!
It appears that we will soon add a few more defaults to that running total. PIMCO CEO, Mohamed El-Erian, summed up the bottom line as simple yet consequential, “The Greek debt crisis has morphed into something that is potentially more sinister for Europe and the global economy. What started out as a public finance issue is quickly turning into a banking problem too; and what started out as a Greek issue has become a full-blown crisis for Europe.”
Plainly, we agree. In addition to our year-end letter, we shared our thoughts on Europe’s struggles here, here, here and here. We’d also recommend investors take a look at the Economist’s interactive guide to Europe’s economic woes, The PIIGS That Won’t Fly. With interest rates exploding higher and excessive fiscal spending likely to be reined in, the currency appears to be the only release valve. According to the Economist’s most recent “Burger Index,” the Euro still has a ways to go before reaching fair value on a purchasing-power-parity basis. Given the prospects for an extended deflationary period ahead, we think the odds of a downside overshoot are “strong to very strong.”