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Update on the European Debt Crisis

By WealthTrust Arizona

The world continues to keep a close eye on Europe, and with good reason. The debt crisis there – and how it is or is not being handled – continues to affect world markets and, ultimately, your portfolio, regardless of the quality of your holdings or how well diversified they are.

The Eurozone’s Weakest Links

If the Eurozone has an Achilles' heel, it would be Greece and Spain. Greece’s relatively small economy (it is the world’s 36th-largest economy, with a Gross Domestic Product, or GDP, of only $305 billion) means it accounts for one-sixtieth – a mere 1.7% – of the total GDP of the $17.6 billion, 27-nation European Union.

There are growing concerns Greece's huge bank borrowings and state debts will ultimately bring down its economy, which would only exacerbate the situation. Greece might ultimately end its 13-year run of using the Euro as its official currency, reverting back to the Drachma. If that were to happen, some think it could be a good thing, serving as a “wake-up call” for Greece and its citizens, forcing them to deal with the hard political and economic decisions they have thus far avoided making.

If Greece did voluntarily increases taxes, reduce government spending, lower pension and other entitlements and generally tighten its belt, its currency will maintain its value. The accompanying austerity and pain would be at least somewhat predictable and controlled. If Greece takes the opposite tack and disdains austerity, the currency market will react accordingly. The value of the drachma versus other currencies would plummet, the price of imports would rise (taking the cost of living up with it), the real earnings of Greek workers would fall and interest rates would rise, which would make credit prohibitively expensive. All of these factors, combined, would further Greece to live within their means, which would lead to austerity measures being imposed.

The Eurozone crisis has affected world markets. For example, the UK's main stock market index fell by nearly 700 points – almost 12% – over a nine-week period. The index of 100 elite British businesses fell 9.5% in two months. Spain has the world’s 12th-largest economy, with a GDP approaching $1.5 trillion. The nation is already struggling with recession and a loss of confidence in its banks, so an unemployment rate approaching 25% certainly does not help matters. If lending criteria tighten and inter-bank rates rise, loans to individuals and businesses will become more difficult to obtain – and more expensive. Such an event has already earned a nickname: “Credit Crunch II.”

Unemployment Up In Eurozone

While our nation’s unemployment rate rose slightly in May – from 8.1% to 8.2% – jobless figures coming out of the Eurozone are even worse. Their jobless rate is now 11%, the highest number recorded since the Euro was created more than thirteen years ago. When you delve into the numbers, the outlook is even bleaker than you might think. In Spain, almost one quarter of the work force is not employed, and more than half of the nation’s young people are not currently working. The U.S. jobless rate showed a slight uptick in the wrong direction, and the number of new jobs – an anemic 69,000 – is discouraging, the fewest number of new jobs created since May, 2011. These numbers are well below the results of a poll of economists which had predicted nonfarm payrolls to increase by 150,000 and the jobless rate to hold steady at 8.1 percent.

It is not just Greece which is facing a tough choice – for all of Europe, the road forward has been narrowed down to two competing choices: Growth versus Austerity. Unemployment has risen in Europe the past few years, despite efforts like bailouts and summit meetings convened to deal with the economic tsunami which has washed over the continent. Some European politicians and officials have begun to reevaluate the strategy of austerity and are leaning toward a shift to growth in conjunction with deficit reduction.

In recent parliamentary elections in Greece, voters rejected the centrist parties which had worked with EU authorities on an austerity program, in exchange for a large bailout earlier in the year. Fringe parties from both the right and the left, which are opposed to more austerity, garnered an impressive portion of the overall vote. These results increase the odds that the Eurozone will be forced to split before 2013, and Greece’s departure would be a key element in that scenario.

The economies of both Greece and France have not performed as well, thanks to factors such as a fiscal deficit exceeding the EU limit of 3%, along with a depreciating Euro. But those countries were not alone in dealing with these kinds of issues; at times, Germany’s budget shortfall has also been above 3%. The dip in the German unemployment rate should not be attributed to fiscal or monetary easing. More likely it is a result of the more flexible labor markets which came about as a result of the structural reforms instituted in Germany over the past decade, which resulted in German workers becoming more productive than their European counterparts.

If Greece Replaces the euro

Greece has come to typify the European debt crisis. The nation, now in its fifth year of a recession, has taken measures to reduce its massive debt, instituting austerity measures, raising taxes and cutting spending. There is much speculation that Greece will replace the euro with a weaker drachma. Recently, an estimated 700 million euros fled the Greek banking system in one day alone. At least one ratings agency has already said that it would place all Eurozone countries on credit watch if it appears Greece will dump the euro. In a worst-case scenario. Greece defaults on its debt, and bank runs spread to Spain and Italy. One of Europe’s largest trading partners, China, slows further, which depresses demand for commodities. Prices for stocks and commodities fall and recession leads to further political crises in Europe.

Unfortunately, if this scenario plays out, it would happen at the same time the United States hits a fiscal brick wall. Unless Congress acts, taxes will rise and government spending will fall at the end of 2012. High unemployment rates, economic and political instability and burdensome debt have all combined to ensure that what happens in Europe has repercussions well beyond the continent. Financial markets abhor uncertainty; given that the Eurozone will undoubtedly remain mired in uncertainty for at least the next few months, you should not let the vagaries of the current global situation guide your every financial move. While you should certainly monitor the situation, do not let every financial twist and turn derail a carefully constructed investment game plan. If you have not already done so, now is the time to adopt a long-term approach to your portfolio, keeping in mind that the old adage still holds true: slow and steady wins the race.

 

DISCLOSURE: WealthTrust Arizona is a fee based investment advisory firm that specializes in integrating portfolio management with estate planning for high net worth individuals and families. Services include portfolio management, estate planning, asset and lifestyle preservation, taxation concerns, access to trust and estate documentation preparation, business succession planning and more. The professionals at WealthTrust -Arizona are frequently sought out by the national media such as The Wall Street Journal, Forbes, New York Times, CNBC, BloombergRadio, and others to share their thoughts on matters that impact our clients.

Given the recent events impacting investors and their financial security, we would welcome the opportunity to provide a second opinion for anyone who would like to have a check-up on their investments, financial plan or estate plan. If you know of anyone who may have a concern with their current advisor or current investment portfolio, we encourage you to share our contact information with those that could benefit from a complimentary review.

Advisory services offered through WealthTrust Arizona, a registered investment advisor. WealthTrust Arizona does not engage in the trust business in the state of Arizona or in any other jurisdiction. Not FDIC insured. Not bank guaranteed. May lose value, including loss of principal. Not insured by any state or federal agency.

 

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