The future of the euro is under threat. There are reasons to be fearful, but there is also reason for hope.
Amidst all the gloom of plunging stock markets, the violence and death in Greece, there is hope.
But first, the bad news.
As reported on Bloomberg, European Central Bank council member Axel Weber said Greece's fiscal crisis is threatening "grave contagion effects" in the euro area.
Buy Greek Bonds, If You Dare
Markets still don't believe the massive IMF and Eurozone bailout will save Greece defaulting on its bonds. Its 2-year bond yields still yield close to 15%. In a world of ultra-low interest rates, it's a great return. But would you take the risk? Me neither.
Weber said that Greece defaulting on its debts "would in the current very fragile situation pose a significant risk to the stability of the monetary union and the financial system."
The very future of the Euro is under threat. German Chancellor Angela Merkel warned the Greek rescue package was about "…the future of Europe and the future of Germany in Europe. We're at a fork in the road."
Two Major Problems With The Euro
Indeed. This sovereign debt crisis is highlighting at least two major problems with the Euro right now…
1) Individual countries, like Greece, haven't got the option of devaluing their currency in order to increase the competitiveness of their exports.
2) Labour is largely not transferrable between regions. Unlike here in the UK, where people are able to move to where the jobs are (often London), the people of Athens are not likely to move to Berlin or to Paris in search of a job. They are stuck where they are, jobless and without much hope.
You Have A Problem
The major threat right now is not so much directly to the Euro, for it is highly unlikely to be broken up before some even more serious intervention by the European Central Bank, including buying the junk bonds of Greece, but of the contagion spreading to Spain and Portugal.
There may not appear to be a crisis in those two countries right now -- Portugal's budget deficit is projected at 8.3% gross domestic product -- but as the Financial Times says, "…if the market thinks you have a problem, you have a problem."
The market is fearful. Fearful and panicked markets do strange things. It's exactly that behaviour that saw the FTSE 100 plunge to below 3,500 in March last year.
To emphasise that fear, Portuguese 2-year bond yields yesterday jumped 70 basis points to 4.5% per cent, while Spanish yields rose 20 basis points to 2.25%.
Correction Territory
With those sorts of yields, we're not talking a Greek situation here, far from it, but markets are definitely nervous. And markets hate uncertainty, hence the FTSE 100's 8.4% slump in just the last 12 trading days. A couple more days of this and we'll officially be in correction territory.
But there is hope. It's highly unlikely this whole sovereign debt brouhaha will turn into a full-blown Global Financial Crisis Mark II.
For starters, banks and companies have just spent the past 18 months deleveraging. They have collectively been reducing their risk profiles, because they were forced to do so, but also because they wanted to, not wanting to go through another major liquidity crisis ever again. Same for all of us.
Secondly, world economies are already recovering. The recovery may be relatively tepid, but it is there, especially in the world's largest economy, the US.
Thirdly, the Euro is already being devalued, dropping to a 15-month low of $1.28. The weakness will ultimately benefit export-led economies such as Italy and Ireland. Others will follow. Could the Eurozone replace China as the world's manufacturer? Stranger things have happened.
What It Means For You
As an investor, you have to decide whether the European sovereign debt problems are large enough that they'll last a long time. If so, you'll be best to move your portfolio to a more defensive stance.
On the other hand, if you believe the problems are going to be over relatively quickly, then you needn't really do anything too radical with your portfolio.
But bear this in mind. Reacting to day to day, week to week and month to month news is only going to make your broker rich. And, if you decided to suddenly sell everything today, and were wrong, you'll pay a heavy price for your pessimism.
Regular readers will know I've been defensive for some time now. But that's just me. You need to make your own choices, and be very comfortable with them. As ever, there are reasons for optimism, and pessimism.
Good luck!
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