When Europe Will Start to Recover

By Rick Newman

Nobody can pinpoint the date on which Europe will start to pull out of its financial nosedive. But there's a phrase that captures the general idea: one minute to midnight.

That's a reference to the "doomsday clock" meant to indicate the risk of a nuclear confrontation during the Cold War. There's a twist with regard to Europe, though: While "midnight" would be ugly and painful, it would also, theoretically, represent a breakthrough, because it would trigger the kinds of reforms needed to get Europe back on track.

"The only time you get real action is at one minute to midnight," says Ewan Cameron Watt, a portfolio manager at investing firm BlackRock. "Then they'll make the next move."

Meanwhile, the world's best investors are intently trying to guess how the drama will play out and place the right bets. The incremental drippiness of the problem has lulled many casual observers into a fitful snore, but it might be time for anybody with an investment portfolio or an interest in the fate of the economy to perk up, because midnight seems to be approaching.

This summer, Greece will run out of money if it doesn't get another tranche of rescue funds from its European creditors. There might be a last-minute deal to avert that, but Greece is coming perilously close to snubbing the draconian terms imposed by lenders. Even if it does finagle another round of funding, Greece's eventual exit from the euro looks more and more inevitable. "Our baseline assumption is that Greece … staggers on in the euro until 2013, but must ultimately exit," forecasting firm IHS Global Insight recently informed its clients.

Some aspects of a Greek exit are already playing out. There are runs on Greek banks, for instance, as depositors withdraw euros out of fear they'll be forcibly converted to less-valuable drachmas. Many workers and businesses are refusing to pay taxes, which intensifies the government's money woes. That could force the government to start issuing IOUs this summer. "That introduces a parallel currency," says Cameron Watt of BlackRock. "In doing that, you've more or less left the euro."

Not long ago, the exit of Greece from the eurozone was considered an unthinkable catastrophe that would light off the demise of the whole union. No more. Planners in Europe now talk of a managed Greek exit, and some analysts think it might be even be a useful "Lehman moment." That's a reference to the Lehman Brothers bankruptcy in 2008, which virtually seized up global financial markets but also provided the impetus for massive government intervention in lieu of smaller incremental moves. That overwhelming force is what finally stabilized the markets.

If Greece goes, full-blown contagion fears will probably spread quickly to Spain and perhaps Italy. Borrowing costs for those countries would skyrocket, and bona fide bank runs would probably begin. That's the point at which the European Central Bank and other European policymakers would almost have no choice but to intervene decisively, with rescue funds and new measures such as centrally guaranteed bank deposit insurance for all eurozone countries—similar to FDIC insurance here—to prevent financial panic and persuade depositors to keep their money in the bank.

This slow-moving train wreck is obviously causing huge swings in stock prices and chasing many risk-averse investors to the sidelines. But there could be a huge rally if it appears that European governments are finally going all out to save the eurozone, even if it's a smaller eurozone.

Cashing in on that requires a lot of faith and good timing. First, you have to believe that European leaders will finally act decisively when the crisis appears close to a culmination point. Second, you have to believe that whatever they do will work. You also have to make a good guess about when one minute to midnight will occur, and endure the agonizing losses that could take place right before it, at two minutes to midnight. But if you do, you might be richer by dawn.