An Idiots Guide to the Europe Debt Crisis

The news keeps being dominated by the European debt crisis, but very few people actually know what is going on.  I will attempt to explain whats going on in Europe in a way that everyone can understand.

Ben Bernanke

Let's start with the United States.  In the US, we have the Federal Reserve, which saved us from complete financial collapse in 2008.  The Federal Reserve is run by Ben Bernanke, who is going to be referred to as the US Financial Mob Boss from here on out.  Since the US is one singular entity, our Financial Mob Boss was able to act swiftly in an effort to save us.  Not so in Europe.

Europe has something similar to the Federal Reserve, but since there are many countries in the European Union, it takes to long to get everyone in agreement on a potential rescue package.  This renders the European Financial Mob Boss useless.  Since the US Mob Boss is the only way we survived the crisis, what is Europe going to do?

The problem is that European countries have been living way outside their means.  Lets pretend that you are Greece, and you make $100,000 a year (good for you!).  Unfortunately, this is not good for you because you spend $500,000 every year.  To make up the $400,000 difference, you ask your neighbors to loan you money.  You do this for 50 years.  Eventually, the people will ask for their money back, but you are going to have to say "sorry, I don't have your money."  This seems crazy that Greece could let this happen, but they did and it is now all of our problems. 

Merkel and Sarkozy

Currently, Germany and France are in robust financial conditions, and are able to prevent Greece from defaulting based on their own bailouts to Greece.  Germany is led by Angela Merkel, and France by Nicolas Sarkozy, and they are really the only two people who have the power to divert this crisis.  A Greek default would send shock waves through the European system as people would doubt the monetary ability of the Euro.  Greece is one of the smallest economy's in Europe, so the media made this out to be a bigger deal than it actually was.

A much bigger issue is Italy, which is the 3rd largest economy in Europe.  Italy is too large to fail, but also too large to bail out.  This has epic disaster written all over it.  Let's pretend we are climbing up an icy mountain.  France and Germany are the leaders, and are very experienced climbing mountains.  Most of the EU countries aren't great climbers, but they can pull their own weight.  When climbing a mountain, generally all the climbers are strapped together so if someone falls they don't automatically fall to their death.  Everyone is strapped together, and Germany and France are leading the way up the mountain.  Then there is Greece at the end.  Greece is a small child, which is dangling at the end of the rope.  The child is doing nothing to help climb up the mountain.  While not ideal, this is okay, since Germany and France can easily keep climbing with the dead weight hanging at the end.  Now let's add Italy at the end.  Italy is a 1,500 pound sumo wrestler, who is currently pulling his weight climbing up the mountain.  There will come a point in the near future that Italy will reach the point of no return, and just let go of their ice pick.  Germany and France will instantly feel the weight, and will immediately dig their ice picks into the side of the mountain and hold on for dear life.  Unfortunately, the weight of Italy is too strong, and the leaders lose their grip and everyone starts free falling down the mountain.  There is no way to save them once this starts happening. 

This is the dangerous path that we are on right now, and we need to do everything in our power to make sure that Italy does not take down all of Europe with it.  The scary part here is there are no real solutions to this mess.  2012 is going to be a wild ride for investments.  I think that the market might do well in the short term, but after the holidays, I could see the market going down like we have never seen before.  If you have any gains at that time, it may be wise to sell and ride this coming crisis out.