The Eurozone Crisis

The Eurozone Crisis… On AND Off the Pitch

By Eric Fry

06/28/10 Laguna Beach, California – The Eurozone Crisis: The Europeans can’t balance a budget…or win a soccer game. More below. But first…

The gimpy US stock market continued limping along last week. The Dow Jones Industrial Average stumbled 307 points, or 2.9%, to 10,144 – pulling its return for the year-to-date solidly into the red.

Just a few months ago, in the hopeful days of late April, the Dow breezed through 11,000 on its way to a pleasing 7% gain for the year thus far. At that moment, the Dow was also sitting atop an incredible 70% jump off the lows of March 2009.

But the tone and behavior of the US stock market has changed a bit since then. The animal spirits that were chasing share prices higher have gone into hibernation. And as share prices fall, so do the hopes and expectations for a strong economic recovery.

Markets make opinions, as we never tire of observing. So no one should be surprised that the slumping US stock market is making the opinion that the economy is less than rosy. And a steady stream of downbeat economic data is reinforcing that opinion. Just last week we learned that homes aren’t selling very well. Before that we learned that employers aren’t hiring very well. And before that we learned that consumers aren’t consuming very well. When you add it all up, it’s easy to understand why investors aren’t investing very well…and why the stock market’s June swoon continues.

For some weird reason, June is often a negative month for stocks. In fact, along with September, June is one of only two months on the calendar that has produced a negative return during the last fifty years. Thankfully, however, during this particular June, the World Cup has provided a welcome diversion.

Some of us Americans, for example, have turned our attention to the home team’s thrilling exploits. Could these “cardiac kids” carry their good fortune into the first round of playoffs? And could this team advance far into the tournament?

The answer arrived quickly, as the American team lost to Ghana on Saturday. Although disappointing, the American loss was not out of line with expectations. The US team was never a favorite to advance far in this year’s World Cup.

By contrast, some of the perennial favorites turned in abysmal performances. France fell early; Italy shortly thereafter…and England after that. Because of these shockers, the 2010 World Cup has started to feel more like a macro-economic metaphor than a sporting event. Of the six G-7 countries to field teams in this year’s World Cup – France, Italy, United Kingdom, Japan, Germany and the United States – only Japan and Germany remain.

Meanwhile, all four nations from the core of South America’s Mercosur economic zone – Argentina, Brazil, Uruguay and Paraguay – remain in the competition. Indeed, Uruguay has advanced to the quarterfinals for the first time since 1970.

Punctuating this remarkable metaphorical contrast between Emerging Market nations and the traditional economic powers of the Developed World, the soccer teams from Chile, Ghana, South Korea and Slovakia all advanced to the Round of 16, even while the teams from Switzerland, France, Italy and Australia were taking flights back home.

The “Azzurri” – as the Italian team is known – faced an especially hostile homecoming. The Italians had not produced such a poor World Cup result in more than 50 years. And that’s not all; the Italians are the reigning World Cup champions from the 2006 engagement. As a result of their early exit therefore, the Italian team joined the ignominious list of defending champions who failed to advance out of pool play. The others include France (2002), Brazil (1966) and the 1950 Italy team.

Italian newspapers showed no mercy, comparing the defeat to the weakness of an entire nation. “Azzurri, the mirror of a country,” a writer for the independent newspaper Il Fatto Quotidiano remarked. “A country without memory, without identity, without an idea of the future.”

This assessment is perhaps is bit too harsh. But certainly, “ideas of the future” are in very short supply – both in Italy and in the rest of the heavily indebted Western economies. Every Western nation has plenty of ideas about how to spend money it doesn’t have. But none of them has a clue about how to correct the excesses of decades-long deficit-spending.

Instead, the most popular “idea of the future” also happens to be the most popular idea of the past: Increase government spending to “stimulate the economy,” rescue too-big-to-fail institutions and maintain “essential” social programs and entitlements. An inescapable corollary to this idea of the past, present and future is that the government MUST borrow money it does not have in order to continue its do-gooding and society-improving.

Your editors here at The Daily Reckoning think this idea is a bad one…and that the time has come for a good idea…or at least a new bad idea. The old bad idea, like the old Italian soccer team, has led us to a bad result – a dead end.

Perhaps it’s time for something entirely new…like allowing the economy to stimulate itself…without government help.

Perhaps its time for some ideas that are so old they would seem entirely new – ideas like allowing too-big-to-fail companies to fail, or mortgage-holders to default, or property prices to fall. And perhaps, if these processes proceeded without government impediment, economically infirm entities and practices would perish – making way for renewed growth.

A few years back, the Argentineans, Brazilians and Uruguayans allowed lots of things to fail, including their own currencies. Today, their economies are revitalized and ascendant. The Mercosur nations have not established an economic heaven on earth. Far from it. But neither are they devoting every sinew of their national muscle to digging themselves out of debt.

Government debt relative to GDP is lower in both Brazil and Argentina than it is in every single G-7 country!…Meanwhile, the Mercosur’s GDP rose last year, even while the Eurozone’s GDP fell.

“This is the result of a process,” Italy’s Corriere della Sera newspaper explains. “This is not the failure of a single mission… The problem is what we have become.”

An observation about a failing soccer team or about a failing economic system? Let the reader decide…

[Eric’s note: Here’s a brief P.S. to last week’s series of reader emails about the “benefits of expatriation.” One observant reader sent along the following correction:

“In today’s Daily Reckoning the article TEN BENEFITS OF EXPATRIATION strongly implies something that I think is very misleading, and is substantive. Section #2 ends with sentence ‘Expatriation lifts the death tax burden...’

“About 15-20 years ago, I looked into the pros and cons of expatriation, as I was legally resident outside the US. My research indicated that there were 2 drawbacks that are not mentioned in the article. First, to take away the economic incentive to expatriate, I understood that the US had instituted a policy whereby you would have to pay a fee, quite similar to the inheritance tax, in order to renounce citizenship. While it was not clear how they would collect it appeared there were some mechanisms. Perhaps this policy was changed. If not, it should be explained, since the article implies that you simply renounce citizenship to reap the benefit for your estate.”

After doing a little digging, your Daily Reckoning editors unearthed the following information:

An “exit tax” applies to anyone who renounces their citizenship, if they have had more than $129,000 in tax liability, on average, for the previous five years or if they have more than $2,000,000 in net worth.

If the tax applies, there are two pieces. First, all of your worldwide assets are treated as sold, with the result that you are then taxed on the capital gains. As to this piece, no gains, no tax.

Secondly, things like IRA accounts are not taxed as if sold, but rather are deemed to have been distributed, thereby triggering ordinary income recognition on those amounts. There are various nuances but that appears to be the gist of it. Please speak with a professional and informed accountant to be sure of these details.]