All That Euro-Angst: What's It To You?

Last Updated May 7, 2010 11:56 AM EDT

Britain paralyzed itself Thursday with the electoral equivalent of a hung jury: No party picked up the majority necessary to choose the next prime minister and it's likely that matters there will be stuck for a while. Add that to the worries about the Greek debt crisis and financial instability in Spain and Portugal, and you've got a serious case of continental angst. Euro stocks and the continental currency have been losing value all year.

But why are Americans panicking? This morning U.S. investors woke up and, supposedly worried about troubles in Europe, continued selling off U.S. stocks. Yesterday's U.S. market meltdown may have been set off by a computer glitch or a clumsy trader, but the sentiment behind it was "worries about Europe," according to just about every analyst who got near a microphone or keyboard.

Why are U.S. investors so worried about Euro troubles, and specifically, the euro? The dollar has climbed roughly 19 percent against the euro since mid-December, 2009. Shouldn't we be happy that the almighty dollar will buy more fromage et vin than it has in a long time?

Of course, there are some other effects to think about.  A weak Europe with a weak euro means less demand for American goods, just at a time when U.S. manufacturers were starting to pick up a little bit of steam.  And U.S. banks hold about $1 trillion in European debt, so when those bonds are downgraded and degraded by cheaper prices, it hurts them, too. Individual investors who own foreign stock and bond funds (and you should, if you want a truly diversified portfolio) can find the returns in those funds hurt by the falling euro.  A recent study by Charles Schwab found that when the dollar was rising against foreign currencies, it took 3 percent to 16 percent off of foreign stock fund returns.

But there are some positive effects, too. European instability, contrasted with signs of a U.S. recovery, means that U.S. Treasuries are again gaining strength as a safe haven for the rest of the world.  And that buys the U.S. more time to finance and fix its deficit with cheap loans from China and Japan. Those Asian countries could start buying more American goods as European goods get too expensive.

This could be a long, steady slide. BNP Paribas predicted on Thursday that the euro will hit parity with the dollar during the first quarter of 2011. American investors who are willing to move in a measured way could benefit by continuing to buy some European shares and bonds as a balanced part of their portfolio. They'd be betting -- with big fat dollars buying cheaper shares -- on a recovery that lags ours, and on a European Commission that will ultimately bail out its debtors. Their long-term reward could be bigger bond yields and enough earnings to cover that weekend in Paris.

photo by HaPe Gera at Flickr.

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