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Severe Europe-Wide Recession Likely for 2012

Once again, as an aside, under this scenario, you can expect the value of the euro to fall relative to other currencies. Of course, if the U.S. Fed embarks on QE3, the euro's relative value to the dollar may well hold.

Recidivism?

Of course, once the crisis atmosphere passes and things settle down, under this most likely scenario, the peripheral countries may not feel the pressure to continue with their promised austerity. Don't forget, politics plays a large role and austerity often leads to political defeat for those politicians who negotiated it. Already we have seen political changes in Greece, Italy and Spain as a result of this crisis.

Perhaps these countries will follow Greece's lead and hire Goldman Sachs to help them issue off the books debt so that they have the appearance of complying with their austerity promises. That could very well buy several years, as it did for Greece. (Ireland appears to be an exception. After their bailout, they appear to have abided by their austerity promises and have made great progress in addressing their fiscal and economic issues. Then, again, none of Ireland's shores touch the Mediterranean Sea.)

Issues Remain

So, as we enter 2012, the stage is set for some calming over Europe's sovereign debt and the solvency of Europe's banks. Mind you, it may be a rocky road over the near term to get there including setbacks and lots of uncertainty and market volatility. The biggest issues will likely revolve around the magnitude of the guarantees and the capacity of the guaranteeing entities. Nevertheless, the most likely scenario is coming into clearer focus.

Unfortunately, this scenario, or any other one that emerges, means recession in Europe, most likely severe recession. This has implications for markets worldwide, as Europe's economy matches or exceeds the size of the U.S., depending on which countries you include. Once again, the recession, coupled with the austerity measures, may change the political backdrop such that the populations of some of the peripheral countries may well want to exit the EMU.

While 2012 may bring calmer conditions, even if the most likely scenario is executed, the future of the euro and the EMU is still not assured. It rests on the effectiveness of the fiscal controls. If EMU members retain sovereignty over their fiscal policies, then there has to be some mechanism to expel fiscal offenders from the EMU in an orderly manner. Without this, we may well see a replay of this crisis within the decade. Let's hope there is enough political courage to include such measures.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.
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