“I don’t think it’s unthinkable.”
– Warren Buffet on the collapse of the Euro

The grand experiment called the European Union (“EU”) may finally be coming to an end. Portugal is just the latest crack in the armor. We have always been in the camp that the real test of the EU will be when there is a financial crisis. Why? Because the economic history of the weaker European countries – Greece, Portugal and Italy to name a few – shows that when their economies are bad, they have devalued their own currency. They took this action independently of other countries in an effort to spark economic growth in their country. Since the formation of the EU, however, member countries have given up their ability to take independent monetary action like this in return for having their monetary policy set by a collective central bank made up of various representatives from member countries of the EU – negating any ability to devalue their own currency. So what action can these countries take now to spur their own economies? They can do one or both of the following two things: i) be bailed out by other European countries, or ii) take austerity measures. The social effect of these actions is causing the demise of the EU.

Let’s look at what is happening in the weaker countries in the EU like Ireland. We have seen rioting, austerity measures, tax increases and political unrest. In February, the Irish ruling party, who has held power for most of the last 80 years, lost 74% of the seats it held in parliament. Why? The Irish people are unhappy and don’t like other European countries dictating policy to them. Ireland has one of the lowest tax rates in the EU at 12.5%. However, the EU wants to harmonize taxes throughout European countries in order to eliminate competition. France and Germany are trying to force Ireland to raise its corporate tax by offering leniency on loan repayments. Nationalism is rearing its head as the Irish don’t want Germany and France telling them what to do.

Let’s compare this to what is happening in the stronger EU countries like Germany. German people are proud, highly educated and hard working. They also tend to be savers. Many Germans are upset they have to bail out the weaker EU countries. That is why German Chancellor Angela Merkel’s ruling party was decimated in Hamburg’s state elections last month – they had their worst showing since World War II. Many German citizens are asking for the Deutsche Mark to come back. They don’t want their economy to be dragged down by the PIIGS – Portugal, Ireland, Italy, Greece and Spain – and certainly don’t want to give those countries any of their money. Anymore bailouts could possibly lead to the end of Merkel’s political career.

Citizens of both weak and strong EU countries are starting to become disenchanted with their political leaders. Given this, why would Merkel seemingly be ruining her political future by bailing out the weaker countries? It is quite simple. If they don’t, the banking systems in the strong countries would collapse. The Bank of International Settlements published statistics in February showing that European banks have $2.1 trillion of exposure to the PIIGS – excluding Italy. That number is scary enough on its own; however, it does not include derivative exposure.

As we have seen with our recent mortgage crisis here in the US, derivative exposure can significantly compound losses.

Given the turmoil in Europe, some here in the US worry about the dollar collapsing. Just imagine if you were in Germany. How secure would you feel about holding Euros? It is almost impossible to get a safety deposit box at a bank in Germany these days. We believe this is anecdotal evidence that many in Germany are worried about the Euro and are hoarding precious metals. That fear is only compounded when Portugal’s parliament votes down austerity measures and Moody’s downgrades twenty Spanish banks last week. We would not be surprised if Spain was the next country to experience riots as its unemployment rate is now above 20%.

So what does this mean for Europe? European politicians are trying to prop up a system that can not work without people in the stronger countries redistributing their wealth to the weaker countries. At the same time, these stronger countries can’t demand significant changes to the weaker countries without upsetting the people in the weaker countries. In our opinion, this is leading to a significant change in Europe. To save the union, the EU should have kicked Greece out because it broke EU covenants. At this point, we don’t see how the Euro can survive. We believe we are at a tipping point as more EU countries elect more nationalistic politicians. Nationalism is not what the EU is built upon. The end of the Euro might come sooner than people believe. We agree with Warren Buffett’s comment noted at the beginning of this Newsletter.

IRA Contributions

If you haven’t made your 2010 IRA contribution yet, there is still time. Taxpayers can make IRA contributions for 2010 up to April 18th of 2011. Contribution limits are 100% of compensation up to $5000 per taxpayer for individuals who were less than 50 years old in 2010. Catch-up contributions for those individuals 50 and older in 2010 are $1000, bringing the total contribution limit for the 50 and older crowd to $6000.

New Employee

Although you can hardly call him a new employee at this time, some of you may not have had the opportunity to meet our newest employee, Neal Ritondaro. Neal joined THOR in August of 2010. Neal works primarily as a research analyst and financial planner. He also assists with some client relationships. Neal graduated from The University of Akron in the spring of 2010 with a Bachelor of Science degree in finance, with a concentration in financial planning. While in college, Neal spent two years as an intern with a wealth management company in Akron. Neal has completed the required classes for the Certified Financial Planning (CFP) designation and will take his final test in July. In his free time, Neal enjoys playing soccer, supporting Cleveland sports and spending time with his dog Nike. Please say hi to Neal when you are in the office.