We now live in a global village and can’t escape the consequences when something goes wrong in another part of the village. Europe’s economic woes are the concern of every global citizen. The challenge is what, if anything, can we do about it?
How did the problem come about?
Last week I talked about credit cards and how their misuse could bring about a person’s financial downfall. There is a close analogy where countries are concerned. Let’s imagine every country has been issued a credit card.
Some have used it responsibly. An example is Norway, a nation that pays its debts on time and has carefully built up its savings. It boasts an unemployment rate below 3 percent and its people enjoy comfortable, but not lavish, lifestyles.
Other countries, on the other hand, have abused their “credit cards” and have run up huge debts through uncontrolled spending. The biggest offender is the United States, whose national debt is now running close to $16 trillion or $50,000 for every citizen. (Check usdebtclock.org to see a fascinating real-time display.) But the United States has massive resources and enjoys the privilege of being able to pull in funds from all over the world, particularly the Middle East and China, enabling it to remain solvent.
Europe is a different story
Greece, one of the smallest economies in Europe, is not so fortunate. It has seriously overspent in relation to its size and is now relying on its neighbors to help meet its daily needs while it tries to pay off its “credit card.” If it were the only individual in the village in serious debt, it would not be too bad.
The problem is that its larger neighbors in the euro zone, in particular Italy, Spain, Portugal and Ireland, have also been overspending. Their more careful neighbors, Germany and France, have proposed some strict austerity measures to reduce the debts, but the people in those countries have not taken well to the hardships imposed on them. They have protested in the streets and even the French revolted and have elected a more left-wing government.
The result is a big question as to whether the euro zone and its currency can survive. On June 17, the Greeks will elect a new government. If the left wing wins as expected and rejects austerity, the country could be the first to exit the club. Its “credit card” would be taken away. This is not the end of the story. The fear is that other countries will follow suit.
Europe’s woes become everyone’s problem
If countries in the euro zone walk away from their debts, other countries will be badly hit as their financial institutions have invested heavily in Europe and because Europe is a big market for countries like China. If the problem can be restricted to Greece, it is manageable, but if other countries start to default, we are looking at some serious repercussions for the global banking system. This would entail another credit crisis and a withdrawal of liquidity from the financial markets. Stock markets could fall further and emerging markets could see a flight of capital.
We have already seen in Indonesia over the past few weeks millions of dollars being withdrawn from the Indonesia Stock Exchange and a weakening of the rupiah. This is no reflection on Indonesia, but it is a reality of the global village.
What can we do as individuals to avoid the storm?
First of all, we don’t panic. The worst may not happen. Governments are aware of the consequences of a meltdown, so they may come to a consensus after a bit of saber-rattling and brinkmanship and formulate a compromise agreement that keeps the euro zone intact.
In such a situation, markets are likely to rally and we could see a period of optimism and recovery. Those with ample cash reserves who are prepared to take a risk in the short term could well make a quick profit by investing in markets when they are down, as they are now.
But we should also prepare for the worst in the same way that we take out insurance. Safe havens in times of crisis are strong currencies like the US dollar, Japanese yen and Swiss franc. Gold is also a traditional haven in times of uncertainty.
Cashing in investments when the markets are gripped by fear is a natural reaction, but one that usually ensures that the investor never makes any money. Human nature drives people to buy high and sell low. Little wonder so many people make no money in the stock markets, even though they undeniably rise over time.
Regular savings plans are one solution
One way to avoid buying high and selling low is to commit to a regular savings or retirement plan in which the same amount of money is invested every month, irrespective of what is happening in the stock markets. This results in cost averaging, which entails the buying of more units or shares when the price is low and fewer when the price is high.
One caveat: Once a regular plan has begun, it is very important to maintain the commitment. Failure to do so can result in heavy losses through penalty charges, so do not take out such a plan unless you are confident of maintaining it. You should always have ample cash reserves to ensure you never miss a payment.
Basic precautions for adverse times
Keeping ample cash reserves is perhaps the most important principle to follow. If you should lose your job, having cash can see you through and reduce the risk of getting into debt. Thousands of people failed to follow this principle in the United States in the 2008 credit crisis and lost their homes as a result.
Don’t put all or most of your eggs in one investment basket. There are many attractive investment products that are not correlated with stock markets. Some are not as liquid, however, which should also be taken into account.
Until the impact of the euro zone crisis is known, this is probably not a good time to be making a major purchase that requires borrowing money. And it is not a good time to be running up credit card debt. If you do so, you may end up like Greece and have your card taken away.
Colin Bloodworth is the president director of Professional Portfolio International Indonesia.