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Thoughts on Europe


Deja vu

Watching new governments develop is something of a spectator sport for my Generation X. The older part of us cut our political teeth on Morning in America and watched with awe from our college dorm rooms as The Wall fell. The creation of a new form of government in Europe has certainly attracted less notice, but it has not gone unnoticed amongst the political junky segment of my circle of friends.

For that is, after all, what is going on in Europe. The European Union is a new (for them) form of government, specifically a confederacy of separate nation-states who agree to cede specific limited powers and responsibilities to a central government. We Yankees have some experience with that. Anyone who has read our Federalist and Anti-Federalist papers recognizes this instantly.

America's birth came from two separate minds on centralized authority. Our political structure echoes the inherent conflict between the need for centralized decision making in certain obvious areas (defense, interstate commerce, and foreign relations) and the desire to have our leaders within proverbial choking distance for when they get out of hand. America was born in a loose confederacy, modified with the creation of federal taxing authority and a central bank, and forever altered by a bloody civil war - a war that was popularly about slavery but was in fact a horrifically bloody battle between the Federalists and the anti-Federalists.

It comes as no surprise to me that Europe's path towards confederation has turned out to be a little rocky. Just as in America's history where powerful states withheld their votes in order to skew the confederacy to their favor, nations politically powerful within the European Union have done the same. History repeats itself some 230 years later and an ocean away.

So what does this have to do with your portfolio? Simple. Money gravitates away from uncertainty, particularly when there is no premium paid for taking on the additional risk that always accompanies uncertainty. It has been very fashionable to believe a confederated Europe and its eponymous currency the Euro would represent the modern economy. From the pricing of precious commodities in Euros instead of dollars to very public bets against the dollar by the likes of Warren Buffet (who, in my meek opinion, ought to stick to buying good companies and making them better), the bet was on for the EU to eclipse the America.

Certain bears particularly loved this trend as it played into their hate of the FOMC's guidance of the American economy that has, so far, frustrated their desire to finally realize a profit from their bets on the financial collapse of the American economy. A confederated Europe was the ultimate "grass-is-greener" play.

People who ignore history are doomed, as they say. Anyone whose investment thesis was predicated on an easy birth of a European confederacy just got a rude awakening. The idea the certainty the market craves would be in greater supply overseas evaporated with two "no" votes and the cancellation of the UK vote over the weekend. As it turns out, the least uncertain confederation in which to invest one's portfolio still seems to be within the borders of America.

September 11th erased nearly fifteen years of accumulated peace dividend accruing to the American markets. Since that time, money has been casting about for the next new place to feel secure and many people's hopes appeared to be on a solid European confederacy - particularly over the last few quarters. I will watch with interest to see whether those casting about will "rediscover" the American financial markets.

If they do, it will come at an interesting juncture. As Brian Reynolds has pointed out, it appears at least one major segment of bears has finally overextended themselves. As Phil Erlanger recently pointed out here and a while back here, the bears have pressed bets across much of the market. What happens if the peace dividend returns to American shores in force?

Europe's efforts at confederacy will succeed. I don't expect it to happen any time soon, but it will happen. In the meantime, watching the redistribution of capital should be entertaining.

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