By Matt Hougan
Greece is probably going to default. What’s the best way for ETF investors to play it? Buy the euro.
It’s counterintuitive, I know. But hear me out.
I’m not saying investors should buy the euro today. Not yet. Not when S&P credit analyst Marko Mrsnik is playing “this little PIIG-y” with European sovereign debt downgrades. S&P cut Greece and Portugal yesterday, followed by Spain today, so who’s to say Italy and Ireland’s ratings won’t be on the chopping block tomorrow?
First, let’s tackle Greece.
We’re already seeing the cockroaches roll out of the Greek financial situation (there’s never just one Greek financial problem). Just today, the European bailout package has moved from 45 billion euro over one year to 100-120 billion euro over three years, according to The Wall Street Journal. And IMF Chief Dominique Strauss-Kahn says it’s “impossible” to know what the total bailout package will be.
I’ll do the translation: “Bigger than anyone thinks.”
We all know how this plays out. The EU will come through with the first 45 billion euro bailout package, which will prevent Greece from defaulting on May 19, as it’s threatening to do now. Greece will push through a few more unpopular austerity measures, on the back of the one it implemented in February.
Then in a few months we’ll find out Greece is further in the hole. It will ask for more money from the EU, which will say no, as political pressure against a second bailout will be too big. Greece will then ask for more austerity concessions from its citizens, who will revolt against further sacrifice to appease foreign bond holders.
It will end poorly.
Despite all that—and despite the risk of contagion—I think in the end the euro will emerge from all this stronger.
After all, the reason the Greek situation is complex is precisely because the euro is designed to be strong. The economic agreement that binds eurozone countries requires all to maintain low debt loads, and makes it impossible for any of them to inflate away debt by running the printing presses.
If Greece were still on the drachma, it would devalue its currency and that would be that. But because the euro is Greece’s legal tender, that’s not a viable option, and so far it's resisted exiting the euro to effect a devaluation.
I don’t know if Greece will survive as a member of the eurozone, but that’s probably irrelevant to the fate of the euro itself. Greece is a tiny piece of the European economy. In the end, I suspect the euro will emerge intact. I imagine, in the future, that EU member states will crack down earlier and harder on countries that dig themselves too deeply into debt, and the ECB will continue to use inflation as the primary target of its monetary policy. Currency markets should be happy.
Of course, there’s a risk that the euro will crumble. If the contagion takes hold and EU member states, driven by political pressures at home, can’t come together, more trouble could be ahead. It just seems more likely to me that concerns about the euro will peak, as investors begin to disaggregate the euro from Greece’s financial problems.
The two ETF choices to play the euro, the CurrencyShares Euro Trust and WisdomTree Euro Fund, both provide reasonably direct exposure to the European currency. Each has its own advantage.
FXE is hugely liquid. You can trade in and out of the fund at 1-penny spreads, and it has zero credit exposure in the European short-term paper markets.
EU, which invests in short-term European government and commercial paper, has far better tax treatment: Investors who hold the fund for more than one year qualify for capital gains tax rates. No matter how long you hold FXE, any gains are taxed as ordinary income. For me, that makes EU the better bet for long-term investors.
In short, traders should use FXE and investors should use EU.
And if you think I’m nuts, you can short either of them too.