After a meeting in Rome last Friday between Germany, France, Italy and Spain aimed at resolving the eurozone crisis, it appears as though the main sticking point between Germany and its major European partners is the idea of eurobonds. As CNBC noted, while the four countries agreed on a temporary stimulus program of $156 billion to jumpstart growth, they made no progress on the core issue of eurobonds.
Under the eurobond formula, debt issued by individual eurozone members would be collectivized, meaning that the stronger eurozone countries - particularly Germany - would agree to support and underwrite the debt of the weaker members. This would, in theory, use Germany's strong balance sheet to guarantee the sovereign bonds of weaker eurozone members such as Spain, thereby bringing down Spanish borrowing costs.
Needless to say, the peripheral countries such as Italy and Spain - supported by France as well - favor the idea of eurobonds, and have formed a so-called "Latin Bloc" to push Germany to accept some form of "debt mutualization". The Germans, however, have been adamantly opposed to the idea of eurobonds to date.
I found an excellent article in The Guardian recently that succinctly explains all of the issues surrounding eurobonds, and essentially lays out three possibilities for how the eurobond controversy might be resolved:
Status quo - eurozone countries continue to issue their own loans
Eurozone members should live with the consequences of their debts, which in Greece's case is higher borrowing costs
Without sharing the costs of borrowing, weaker members of the eurozone will need bigger loans or 19th century welfare states
Germany, Finland and Austria head the list of countries that want to continue issuing their own bonds
Eurobonds - Brussels takes out loans on behalf of all eurozone members
Sharing the cost of borrowing brings the eurozone further together. Private investors would buy bonds, helping all nations stabilise their interest bill
Indebted countries let off the hook to carry on spending and racking up more debt now it is cheaper
France, Spain and Italy are cheerleaders with new French president François Hollande putting it at the top of his wish list
Redemption fund - a plan to create a common liability for national debts, but tied to privatizations, free markets and austerity
Allows indebted countries to offset some of their sky-high borrowing costs against Germany's lower rates
A complicated half-way house that satisfies no one. Likely to last only a few months before Greece breaches agreement and Germans withdraw
Council of economic advisers to German chancellor Angela Merkel and opposition SPD officials who see it as the best compromise
As the chart lays out, from Germany's perspective, if they are going to be on the hook for the debt of the Italians and Spaniards, then they want to be able to enforce Teutonic discipline on these countries in the form of privatizations, free markets and austerity.
The Telegraph had an article summarizing Friday's summit, which included a statement from Merkel which neatly encapsulates what Germany would expect in exchange for its support:
"Each country wants to help but if I am going to call on taxpayers in Germany, I must have guarantees that all is under control. Responsibility and control go hand in hand," she said after a crucial summit of the eurozone's Big Four powers in Rome."
There will be a full EU summit on June 28 and 29, and leaders will be under extreme measures from markets to announce some kind of comprehensive plan to deal with the eurozone crisis. The problem as I see it, however, is that the politicians and the markets are working off different time clocks (as they frequently do), and meanwhile the possibility of a complete eurozone meltdown continues to grow.
From an investing perspective, I think it would be wise to consider how to protect yourself from the fire engulfing Europe. One option is to play the continued rise in the value of the dollar against the euro. For this trend, the natural ETF to own is the PowerShares DB US Dollar Index Bullish (UUP), which holds 58% of its assets in in long dollar/short euro positions. Alternatively, you could short the Rydex CurrencyShares Euro Trust (FXE).
I believe two other currencies, the Swiss Frank and the Japanese Yen, are also seen by markets as safe havens from the eurozone crisis. The Swiss Frank can be accessed via the CurrencyShares Swiss Franc Trust (FXF), while the Japanese Yen can be played through the CurrencyShares Japanese Yen Trust (FXY).
Finally, while I certainly understand the argument against Treasuries, I have long believed that Treasuries offer an excellent hedge against equity volatility. I like the iShares Barclays 10-20 Year Treasury Bond ETF (TLH) for medium term Treasuries and the Vanguard Extended Duration Treasury ETF (EDV) for long term Treasuries. If equity markets head south due to a eurozone crisis, you can at least feel confident that your Treasury bonds will provide some protection as investors rush into what remains the ultimate safe haven.
Disclosure: I hold Treasury bonds in my 401(k).