January 16th, 2012

European Roulette

Most people take little comfort from the fact that as slow and lethargic our economic recovery may be, the European Union is in far worse shape. In fact, because the problems across the pond are far greater than those in the US, we should pay close attention to what’s going on there, and what the potential consequences might be on this end.

The underlying problem is that the European Union and their fixation on creating a common currency was flawed. Although the EU created the Euro and agreed on standardized value, the currency is supported by the individual treasuries of the member nations, not by a common banking authority. So when Greece and Italy encounter national credit problems because of their internal fiscal policies, the overall security of the Euro comes into question.

Every time fellow EU members step up to bolster the credit problems of Greece and Italy, the underlying problems become even more severe. Many experts believe that ultimately the Euro will crumble, necessitating the recapitalization of the European banks. This event, in and of itself will not be catastrophic so much as cathartic, enabling the EU to restructure with a minimal amount of pain, and to move on. But for everyone involved, it will clearly be traumatic.

This translates to the equivalent of Russian Roulette for the American economy because these events create uncertainty, and one thing capital markets detest is uncertainty. American investors – individual and institutional alike – don’t know what’s actually going to happen in Europe and when it’s going to happen. This serves to slow down the US economic growth because the capital investment that is so critical to growth is being held on the sidelines as investors wait to see what’s happening in Europe.

US economic growth is also hampered by the fact that a weak European economy means less US exports to Europe. At a time when the US depends on its friends to buy more and more products, the Europeans are buying less and less. It’s a vicious cycle that further impedes the ability of the US to bootstrap itself out of its fiscal malaise.

Welcome to the new reality of the global economy. What happens here matters over there and vice versa. And unless you know how to protect yourself from this kind of international volatility, regardless of where you keep your assets and regardless of what form they are in, you are at risk.

That’s why today, more than ever, it’s important for you to not only understand what’s going on, but what to do about it. Believe it or not, the upheaval in Europe not only creates risk for American investors, but opportunities for them as well. It’s a classic case of the double-edged sword. The question is whether you know enough about financial management to hedge your risk, and to both spot and capitalize on the opportunities.

By the way, don’t even think about asking your financial advisor about this. Those days are long gone. A much more practical approach is for you to master these skills yourself, diversify your holdings and to take responsibility for managing your own wealth creation and growth.

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