Why And How To Short The Euro Using ETFs

Includes: EUO, FXE
by: Richard Berger

The Euro is a currency without a country. The idea of a monetary union without a political union is madness. Even the founders of the Euro monetary zone knew this. It was their belief that they could force political union of Europe by first linking the European Community through a common currency. To understand the nature of the global monetary system and the euro's place in it, a brief post war history is advisable.

In July 1944, even as World War II still raged across the globe, 730 delegates from all 44 allied nations met in New Hampshire and signed an agreement providing for the leadership and prosperity of the United States for the 67 years. This agreement, the Bretton Woods Treaty created a system of institutions, rules, and procedures for regulating the international monetary system. Its principle structure was to establish the U.S. dollar as the basis for all other currencies of the globe by requiring all nations to establish a monetary policy focused on maintaining fixed exchange rates to the U.S. dollar. In turn, the U.S. dollar was freely convertible into gold. Thus the global monetary system was fundamentally backed by gold.

On August 15, 1971 the United States abandoned the gold backed dollar, no longer allowing the free exchange between governments of dollars for gold and replaced it with a fiat currency. This unilateral action brought the Bretton Woods system to an effective end. Thereafter, the U.S. dollar has been serving as the global reserve currency and global markets have valued national currencies on a floating rate basis instead of the fixed exchange rates of the post war era. This was the first shot fired in the post WWII monetary wars, a series of battles still quietly being waged for global economic domination. The late 1970s and 1980s initiated currency wars between nations jockeying for position to maintain protectionist markets at home while using relative currency exchange rates to obtain favorable export market dominance.

The European Economic Community (EEC) had been established as a trade zone in 1957 by the Treaty of Rome. This evolved into the Common Market, a structure with the goal of competition without barriers to economic and industrial activity within the member States. While creating a free market environment inside the zone, use of tax incentives and direct subsidies provided a strong protectionist moat around the EEC.

The destruction of Bretton Woods by the United States in 1971 led to a destabilization of the EEC trade zone brought on by highly fluctuating free floating currency exchange rates. The Community reacted by an agreement, commonly referred to as "the snake", to limit the fluctuation between their member currencies to 2.25%. This quickly proved to be unworkable and saw Britain and Ireland forced to abandon the system while the German currency advanced strongly.

In 1978, the European Monetary System (NYSE:EMS) was created to replace the failed "snake" and the Deutschmark became the benchmark currency of the system. Like the snake, the EMS required members to maintain exchange fluctuations within 2.25%. It went further by requiring member Governments to actively intervene in the currency markets if the deviations rose above 75% of this target. This marked the first real step to a joint Euopean currency with a set of rules mandating a mechanism for stability of the exchange rate among members.

Britain joined the system in 1990 but was soon to become the harbinger of its doom when in September of 1992 The Bank of England was forced to spend £18 billion in an unsuccessful attempt to support the value of the pound sterling. Portugal and Spain was similarly forced to exit in 1995.

Thus, by this time, the problem of linking a group of independent currencies through forced market intervention in support of exchange rate stability was becoming an obvious impossible challenge.

The Treaty of Maastricht, signed in 1991, created a unified currency, the Euro, for the qualifying European Union nations. It was the next attempt to stabilize trade advantages within the Union and create a unified competing unit as a global reserve. Criteria for qualifying as Euro Zone members included a limit on government deficits to 3% of GDP, corresponding limits on inflation, and continued participation in support of market intervention when exchange rate fluctuations reached 75% of the targeted limit of 2.25% allowed between member currency rates during the interim period leading to the 2000 issuing of a the common Euro currency. By 2002, 12 nations of the 15 nation EU had become Eurozone currency members.

Pressures to cut spending to bring deficits below the 3% GDP required for Euro membership quickly led to social instability. This was soon followed by creative book keeping to maintain the appearance of compliance with the 3% GDP deficit limitations. Pressures continued to accelerate until the 2008 global liquidity crisis, and the severe economic dislocations it revealed or triggered, created a series of crisis flash points in meeting deficit limit mandates in all but a few Eurozone member nations, a situation that continues to increase in volatility today.

Thus, the history of the European trade block and emergence of the Euro as a tool for this block is a history of failed goals and objectives. The linkage of a unified currency without unified political policy is impossible. Currency policy is the fundamental tool of political and social policy. With democratic constituencies unwilling to support significant tax increases (as well as such tax policies being anti-competitive to global economic activity), national governments turn more and more to debt, inflation, and offbook transactions to prop up a decaying system that promises cake while only delivering the cake package wrappings for appearance sake. As the volatile but steady trend of decline in the Euro relative to the U.S. dollar in the post 2008 crisis world demonstrates, the Euro is losing its war against the dollar and its viability as a unified currency zone.

Rather than fostering the needed political union to make the euro a viable currency, history and current times show it has had the opposite effect, creating discord both internally and between the member States.

Click to enlarge

Two ETFs are available to allow investors to directly play the Euro currency either long or short. They trade with a daily average over 1 million shares and are also available as options.

CurrencyShares Euro Trust (NYSEARCA:FXE) provides an ETF which directly tracks the euro's daily move relative to the US dollar. The ProShares Ultra Short Euro (NYSEARCA:EUO) is a leveraged bearish ETF providing 2 times the relevant movement of the euro/usd, a 1% move in relative exchange rate results in a 2% movement of the ETF price.

Either of these ETFs are recommended for euro investments. Political, economic, and trend environments all suggest establishing a bearish position on the euro at this time.

Disclaimer: I am not a licensed securities dealer or advisor. The views here are solely my own and should not be considered or used for investment advice. As always, individuals should determine the suitability for their own situation and perform their own due diligence before making any investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.