The government debt situation in Europe has been the largest driver of market volatility over the past two months. Concern continues to grow that select European countries are close to defaulting on their loans. European banks may have catastrophic exposure to debt problems and there is concern that the problem could spread outside of Europe.
The best review of the situation that we’ve read is a Sept. 29 market bulletin from J. P. Morgan titled “Is a More Integrated Europe the Answer?” The bulletin analyzes the current economic situation among the 17 countries in the European Monetary Union. It provides a very good overview of the issues and suggests that solving this crisis will require “enormous financial, social and political costs.”
Some of the most notable points include:
- Most of the countries in the European Monetary Union (EMU) have different cultures, languages and economic strengths and weaknesses. There is common currency but no common fiscal oversight. There is no common Federal Reserve equivalent to provide liquidity to banks. There is also no ability to influence fiscal policy and taxes across borders.
- The unsustainable financial situation of a few outlying countries in the EMU is forcing politicians in the financially stronger countries to bail out both the euro and countries with burdensome debt. This decision might be good for the EMU as a whole, but is bad for individual countries. In comparing the U.S. financial crisis and taxpayer-supported bailouts of prominent companies, the article makes an interesting point: “imagine if the government wanted to allocate trillions of U.S. taxpayer dollars to help another country pay its bills!” This makes the European challenge very difficult politically.
- Given that the situation in the EU could lead to another global recession, the market strategists at J.P. Morgan encourage investors to “consider alternative strategies, such as long/short and market neutral approaches to help dampen volatility and provide greater diversification.”
This is what we have focused on over the past few weeks.
~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA