Euro End Game: All Roads Lead to Monetary Breakup

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (TheStreet) -- Three major issues must be resolved to save the European Monetary Union (EMU): The value of sovereign debt; the European bank capital issues; and the fiscal capacity or will to provide the needed financing. Unfortunately, no feasible solutions exist. The politicians have done everything they could to keep the market on the edge while, at the same time, continuing to kick the can down the road. The farther the can is kicked, the more painful and costly the ultimate resolution -- the breakup of the EMU.

The Value of Sovereign Debt

As of this writing, the haircut on Greek sovereign debt currently on the table is 50%. The French want as small a discount as possible (it was originally set to 21% in the July agreement which was just ratified by the EMU countries a couple of weeks ago) because French banks hold volumes of Greek sovereign debt.

Germany, the other major player in the drama, wants a larger discount to force the private sector to contribute to the resolution, and because they know that they, and they alone, are the ultimate guarantor. The 50% haircut, however, is really not 50% because the EFSF and ECB, which hold 55% of all Greek debt, are exempt from the haircut. So, at the max, Greece will be relieved of 22.5% of its debt.

However, in order to give Greece a half a chance to survive within the euro circle, the discount should be 80%, not 22.5%%. Even at an 80% discount, Greece's Debt/GDP ratio will still be greater than 90%. At a 22.5% haircut, their Debt/GDP ratio will be so high, and interest payments to outside debt holders so onerous that it will require too much austerity. As we have just witnessed, Greece cannot meet the current required austerity measures imposed by outsiders. If the haircut on the Greek debt is too small and austerity is too severe, which it will be under the current set of principles being discussed, social unrest will continue.

Ultimately, the Greek people will elect politicians who vow to remove the imposed austerity. The rise of Hitler was partly the result of imposed "reparations" from the previous war and the hyperinflation that resulted. If still inside the EMU, the problem of the value of the Greek sovereign debt re-emerges under the scenario now on the table. So, it is vital that the Greek debt haircut be large enough to give Greece at least a chance to succeed within the EMU. Of course, that assumes that there is a shift within Greece away from the entitlement mentality that pervades the culture and that, given a second chance, they will adhere to a fiscal discipline. History indicates low odds of this.

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