Europe problems?

Who knows how things are going to turn out for Europe? Nobody.

There are plenty of people working on resolving the issues. The biggest issue is that governments are finding it harder and harder to finance their spending over and above their government revenues. These budget deficits have been financed with government bonds that various banks across Europe (as well as banks and investors internationally) had bought from the issuing countries prior to the crisis starting.

It is those banks holding those government debts that are cause of concern for Europeans now. Greece is the furthest along however the government turmoil there has placed a new uncertainty on top of everything else. Greece may decide to leave the Euro zone (what some are referring to as “Grexit”) in order to get more control over their economic affairs. There is great debate and lots of unknowns how a Grexit would work. My prior blog on Greece still applies. The problem remains one of strain on banks where Greeks are causing heavy withdrawals on the banks (not called a run on the bank yet) withdrawing Euros anticipating an exit from the Euro currency. This isn’t too rational since they would need to exchange the Euros for the new currency and the new currency would be priced to buy goods and services in Greece so they would net the same purchasing power either way. Only if the Greek person were to spend the Euro outside of Greece would they possibly come out ahead relative to the new currency.

The fear is spreading though to banks in other countries like Spain and Italy. Central banks are most likely keeping a close eye on banks in their countries and helping to provide liquidity to their banks as this is one of their tasks (lender of last resort). My blog on Europe provides more details through those links in that blog.

From an allocation point of view, having some assets exposed to Europe provides an opportunity to buy low through the rebalancing process when the international allocation goes below your target allocation. When you already have the assets, rebalancing sells high those asset classes that have grown out of target relative to the other asset classes, and buys low those asset classes that have shrunk out of target. Thus the sell high – buy low process is reversed. Of course, this does not prevent portfolio value decline (losses). However, it is a recognized strategy to control risk in order to bring allocations back towards their targeted or desired level.

If you have been honest with yourself about your risk capacity and tolerance, then the resulting prudent allocation should be fine … by definition an allocation considers risk and return regardless of the cause of risk or concern.

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