Reports of the Euro's Death Have Been Greatly Exaggerated

The following is excerpted from a letter sent to clients on July 9, 2012.

The Eurozone crisis has been covered thoroughly in the mainstream media, so we won't rehash the entire situation here. However, we thought it might be helpful to provide some big picture thoughts on how we think it might all turn out.

In brief, we believe the European Monetary Union will remain intact. There is simply too high a cost at this point to unwind the Euro project.

If Germany were to exit, it would still be owed a huge amount of Euro-denominated debt by the peripheral countries, much of which it would effectively lose in real terms. Meanwhile, a rising Deutschmark would crush Germany's huge export sector and likely lead to a severe economic contraction. All in all, Germany would likely lose more money by leaving the EMU than it would by staying and bankrolling a rescue of the peripheral countries.

We believe that Spain and Italy are also extremely motivated to remain in the union, as an exit would likely lead to economic and currency disaster for them. It is rarely mentioned that both countries have made significant economic reforms and gone a long way toward cleaning up their fiscal acts. (The same can't be said for the US!)

The economic and political basket case that is Greece may actually end up leaving the EMU, but this has been prepared for and could happen without too much damage to the Eurozone. The economic calamity that we'd expect for Greece if they exited could well provide a good example for other peripheral countries, showing them that exiting the EMU is a brutally painful option and encouraging them to get in line with further reforms.

We also believe that European Central Bank will eventually abandon its purportedly anti-money printing stance and will find some way or another to monetize huge amounts of European debt. This is a key part of our forecast and will be crucial if the Euro is to be saved. Money creation on this scale eventually causes its own problems, but it could eliminate the possibility of default and effectively end the current crisis.

Salvaging the Euro will require many difficult political choices, to be sure, but we believe that a breakup of the EMU is improbable.

There is a lot of brinksmanship going on, though, as everyone involved hopes someone else will make the politically difficult moves first. Thus the crisis will likely have to get more severe before the dramatic moves, most importantly the significant ECB money printing we expect, are made. So we should be ready for continued volatility coming from the Eurozone, but we should also keep in mind that the endgame could very well be less dire than the consensus seems to believe.

In the meantime, some good investment values are being created in Europe. European stock market valuations are now at more than a one-third discount to US stocks (despite the fact that unlike Europe, the US has done absolutely nothing to slow the growth of its crushing debt burden). We are watching these markets closely, and should the crisis get worse in the short term as we expect, we hope to be able to take the opportunity to buy some assets that are priced for very good eventual returns.