Door No. 1, 2, or 3?

What’s the way forward for Europe?

The European debt crisis was caused by debt-financed overconsumption in the South and was brought to a head by the global economic downturn. Suddenly, the debt-burden seemed unsustainable in the face of a contracting economy.

Regional differences now threaten the Euro as a common currency. But European integration has a lot of political will behind it that has been building since the Treaty of Rome was signed in 1956. How will this crisis be resolved?

I see three options: austerity and deflation; transformation and growth; or default, devaluation, and inflation. Each option has its plusses and minuses. The advantage of austerity is its simplicity—just tighten your belt. But this takes political cohesion, which seems to be lacking.

The growth option seems to offer a painless way out. But it requires a cultural shift in favor of entrepreneurship and innovation—which we haven’t seen before. The inflation solution seems to offload the burden onto investors. But investors have a way of going on strike after they’ve been fleeced. Once bitten, twice shy; and it’s hard to finance future growth if the bond market demands much higher rates.

I see all three scenarios as equally likely, with growth best for investors. But hang on to your hats. It’s likely to be a wild ride.

Douglas R. Tengdin, CFA
Chief Investment Officer
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