The Euro zone Issue
Sep 8, 2010
Posted by Jody Eisenman | Filed under Uncategorized
Generally speaking, the phrase “As go financials, so goes the market” holds true. Year to date, the Dow Jones is down a bit less than 1 per cent for the year. The financial stocks, as tracked by the XLF exchange traded fund (ETF), are down about 1.5%. I have usually spoken about the US banking situation. However, the market action yesterday (a drop of over 100 points) was fueled mainly by the European banks. In 1993, 27 different countries got together to form the European Union or EU. The stated goal was to develop a single standardized market for goods and capital. As such, the European Central Bank was established in 1998 in order to administer monetary policy. In a perfect world, the stronger countries would help the weaker ones, this insuring overall growth for everyone.
Unfortunately for the member nations, things didn’t work out quite as planned. What history has shown us is that although countries will sometimes help others, every country’s primary goal is their own self interest. What you have going in the EU now is that several of the weaker countries (such as Portugal, Ireland, Greece and Spain, affectionately known as “PIGS”) are heavily in debt to the stronger nations like Germany and Switzerland. These countries have been spending well beyond their means for years, and when the recession hit, they fell into deep financial difficulty. What has compounded the problem is that most of these countries tend to be socialist, and many of the expenses are in lavish salary and pension benefits to union and government employees. In order to balance their budgets, cuts have to be made (or taxes raised), which was met by the inevitable strikes and riots. Many investors are now rightfully concerned about the health of not only the weaker countries, but the banks that lent them the money. After all, if one or more of these countries defaults on their debt, how would these banks get repaid? Of course, having these banks’ leveraging their capital structure severely increases the problem.
Meanwhile, my central theme has remained the same. The market continues to trade in a relatively narrow range. Barring an extraordinary event, I do not expect this situation to change for awhile.
