After so much chaos, are we nearing the end?
What a year we have had in Europe! I remember starting 2011 with such optimism. The FTSE 100 had bounded up to 6,000, and most investors and pundits were expecting shares to push on from there.
How wrong we were. 2011 has turned out to be a year of turmoil, particularly in the eurozone.
A year of turmoil
From the spring of 2011 onwards, there was an increasing sense of unease about Europe in the markets. There were more and more worries about Greek debt, and the FTSE 100 was unable to break out of its trading range of 5,600 to 6,000.
In July, Greece's debt situation got so bad it had to be bailed out for a second time. How did the markets react? There was the initial relief rally, but then the market realised that the crisis was spreading to the core. Bond yields for Italy and Spain were approaching 7%.
The penny had dropped -- people realised the crisis was spreading to countries that were too big to be bailed out. Suddenly the problem looked far worse than we had thought, and so shares around the world tanked.
After the August slump there was a succession of 'summits to save the euro'. Europe edged towards a solution, with the Greeks' 50% haircut, the installation of the European Stability Mechanism (ESM) and moves towards fiscal union. After every move we have asked, "Is the crisis over?", and each time the markets have answered with a resounding "No!"
What about 2012?
So what does 2012 hold for us? Well, if I began 2011 an optimist, I'm afraid I begin 2012 as a pessimist.
There is no quick and easy fix to the eurozone crisis. If there was, we would have found it by now. But, on the other hand, the constant predictions that the end of the world is nigh have not come true either.
Instead, I think the crisis will rumble onwards, with the eurozone leaders doing just enough at each pressure point to prevent, or at least postpone, Armageddon. I expect that in 2012, Europe will just continue to muddle on.
Angela Merkel has shown that she has been willing to give just a little bit more ground at each emergency summit meeting. She allowed the Greek haircut, the creation of the ESM and greater fiscal union.
Who knows, maybe by next year she will allow a degree of quantitative easing, a larger ESM -- perhaps even Eurobonds.
Meanwhile, austerity in Europe will begin to bite. It will tip many countries into recession, if not downright depression, and the pain will be widespread. Time magazine chose to make 2011 the year of the protestor, but I think if anything 2012 will be worse, with protests, strikes and riots spreading across Europe like wildfire. The riots we had in Britain is just a taster of what is to come.
Two scenarios
So, will 2012 be the euro's last year? Well, I think we are faced with two main scenarios. One possibility is that the pressures that are mounting up in the eurozone's bond markets, combined with the recession that is triggered by swingeing austerity, will prove too much and the euro will simply disintegrate.
What would happen at that point is hard to predict, as I don't think anything like this has ever taken place before. But Europe, and the world, is likely to be pushed into a deep depression, which it would take years to recover from. Contagion would spread across the world's bond and equity markets. Basically, all hell would break loose. And I dare not think what would happen to my shares.
The other main scenario is that the eurozone will muddle on, as I have described in this article. I think -- and hope -- this is the most likely outcome. And as the muddling on continues through 2012, people and markets will start to get used to it. However, the painful deleveraging that this is part of will continue for many a year yet.
Let's end on a positive note
But let's end on a positive note. The euro, which has up to now been surprisingly strong, has started to weaken. It is already 12% down from its peak relative to the dollar and, as the ECB continues to cut interest rates, I expect the euro to continue to weaken.
At last, countries like Greece and Italy will get the opportunity to expand their exports, welcome more tourists and start to grow their economies again. If the ECB finally gives in to demands for a degree of quantitative easing, it might also be able to push down those damned bond yields. Europe would have a fighting chance.
Let's hope it's enough. Fingers crossed...
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