What’s Up With The Euro?

The second is the seemingly intractable inability of Europeans to assume fiscally responsible policies. I don’t want to overstate the case – The United States has recently given up any right to lecture Europe about getting its fiscal house of cards in order. But the seeds of discords were sewn at the outset of the European Union when European bureaucrats – the same dreamers who gave us the League of Nations after the First World War – thought they could make a union that included the conservative German culture and their thrifty ways and their high savings rate, together with the Irish, Portuguese and Greeks.

Think about it… when was the last time anyone trusted the Irish with money?

The third root cause of the European sovereign debt crisis was a savings glut. A massive poverty reduction and the rise of immense middle class populations in China, India, Indonesia, Thailand, and Asia meant that hundreds of millions of new entrepreneurs and middle class workers in these countries had some disposable income. And they didn’t consume it. Instead, they put it in the bank.

The banks had to do something with the money – and they did what banks do: They lent it – any which way they could.

The resulting 20 plus years of relatively easy credit is what led to the immense housing boom in the United States, and fueled loads of consumption and economic growth in the borrower nations, such as the U.S. and most of Europe. Germany, too, contributed to the savings glut, but not as dramatically.

Well, eventually, it comes time to pay the piper, and that’s what’s happened to Europe. Germans still have a strong savings culture, like Asians. But most of the rest of the Eurozone – and especially the periphery, is waking up in a bleary-eyed hangover after over a decade of living it up, to find the credit cards are maxed out, the bill collector is knocking at their door, and worst of all, the kids are still screaming for toys and candy.

So what happens now?

As of this writing, the Greek populace has elected to stay in the Eurozone – at the price of severe austerity. The party’s already over in Greece, and the government is trying to collect taxes from a nation of tax cheats, while substantially reducing government spending. Recession, Greece.

Portugal, Spain and Ireland aren’t far behind.

The German economy is still going strong. And German banks would like to keep lending. They get a nice piece of interest in return for their capital, and they are in a position to keep things going for the rest of Europe. Remember: A much smaller West German economy took on an even bigger burden when they absorbed East Germany – an economic and cultural basket case after years of Communist domination.  But they don’t want to lend money into a black hole.

And that’s why the euro is important.

When countries get into debt trouble, they typically have three choices:

1. Austerity. Increase taxes and reduce public spending – thereby increasing unemployment. The value of the currency is maintained, but at the expense of deep domestic resentment, unpopularity and potentially civil unrest. The people are footing the bill, and they know it. This is a tough row to hoe for democratically elected governments.
2. Default on the loans. Just refuse to pay. But an outright refusal makes it very hard to keep attracting new financing. So a period of austerity ultimately follows, anyway – with much fewer choices, since the government will have destroyed the goodwill of the lenders, who can always send their capital somewhere else. Recession and civil unrest generally follows, anyway.
3. Devalue the currency. The government borrows expensive currency units – and pays the loan back with cheap ones. This was the strategy of Germany to repay its crushing war debts under the Treaty of Versailles, in the 20s through the 1930s.A 50 percent currency evaluation ultimately equates to a 50 percent reduction in debt payments, expressed as a percentage of GDP (assuming GDP is static, which it is not.) However, lenders dislike this, as well – and some have stated outright that a devaluation is the same as a default.

To illustrate how it works, writers have famously illustrated the interwar German economy as one in which you had to bring your deutsche marks to the store in a wheelbarrow to buy a loaf of bread.

This wasn’t much of an exaggeration. But it also meant that the German government could pay off a wheelbarrow full of public debt with the GDP equivalent of a loaf of bread!

As long as those nations most in trouble stay in the euro, though, option three is closed to them. The European Central Bank controls the euro, not Greece, Spain, Portugal or Ireland. And Germany still dominates the banking culture of the European Union. This means it’s impossible for debtor nations to throw Germany under the bus by devaluing their currency. They must either go through a period of austerity and repay the debt, or own the default outright. No concealing it with inflation.

But austerity has its problems, too: A recession in Europe reduces demand for German and American exports alike, for example – and reduces economic growth in both cases. Furthermore, a big pullback in European lending to Latin America threatens a dramatic slowdown in economic growth there, as well. If Latin American banks can’t get liquidity from Europe anymore, because all the available lending output is being absorbed across the Atlantic, and Spain has nothing left to lend abroad, then you have the potential for contagion.

Investors know this, of course… which is one reason why interest rates in the U.S. are still hovering near record lows. Capital has been moving out of Europe by the boatload, resulting in a decline in European asset prices. They buy up safer assets in the United States, and bid Treasuries up to unheard of high prices in what we call “a flight to safety.”

The opportunity, though, is in diversification. What goes up must go down. And there’s precious little upside to owning long term U.S. government debt at less than 4 percent – especially after inflation.

Meanwhile, American investors can buy European stocks more cheaply than American stocks, and Asian stocks more cheaply than either.

The best thing to do, for those with some tolerance for risk and a decade or two left on the time horizon, is to maintain your diversification and asset allocation strategy. Sell off expensive assets in the U.S. Sell off a portion of your overpriced long Treasury bonds, if you own them, and buy up assets at a discount elsewhere in the world. No need to go overboard with it… just maintain a solid footing in many different markets, and many different asset classes. Greece did not abandon the euro, and I don’t think any other countries will, either. Greece was the biggest problem of them all.

We survived the 1997 Asian crisis. And we’ve survived many financial crises before this one. Europe will need to make some changes. But they’ll adjust. They have no choice. Meanwhile, don’t invest by looking in the rear view mirror. Prices already reflect Europe’s problems. They don’t reflect future risks to U.S. treasuries.

Stay diversified, and don’t panic.

How To Protect Yourself Against High Gas Prices

As we mention in our companion article, when airlines get nervous about future price increases in jet fuel, they take steps to protect themselves. After all, airlines are a narrow-margin business, most of the time (actually, they typically operate at the ragged edge of disaster).

They do this in a number of ways: They buy call options – the right to buy oil in the future at today’s prices. They look at modernizing their fleet. They try to lighten payloads. They make sure their office buildings are insulated, and install timers on the air conditioning!

You can do a lot of these things, too. Sure, not on as grand a scale as a global transportation company might. But there are some steps you can take to hedge your exposure to high oil prices.

Lock in your monthly energy costs

Worried about unexpectedly high heating or air conditioning costs later this year? Talk to your utility company. Many of them will average your monthly bill over the last year, and let you pay that amount every month. Sometimes you’ll come out ahead, and sometimes behind. But at least you won’t be surprised.

Keep Your Car Maintained

If you drive a lot, you can generate noticeable savings from two things: Keeping your tires properly inflated, and keeping your engine tuned up. If you’ve got a four-cylinder engine, and one of your spark plugs isn’t firing, you’ve lost 25 percent of your efficiency right there. If your car struggles to get up a hill, even when you’ve got the thing floored, this may be an issue. Otherwise, you may have a head gasket leak or you’re losing compression from somewhere. Get it checked out before driving season kicks in.

Invest in Oil and Gas

Hey, I’m an investment guy. I was going to mention it sooner or later.

Sure, you’ve got some exposure to the oil industry just by owning the S&P 500 (don’t get me started on Apple having a higher market capitalization than Exxon Mobile).

But stocks tend to fall when gas prices rise. Think of the 1970s, when the Arab oil embargo threw the U.S economy into recession and caused a 50 percent fall in stock prices between 1974 and 1976.

So you might want to “juice” your portfolio a bit with stocks that actually benefit from high oil prices to compensate. I’m not talking speculating – this is a risk management measure, taken to protect yourself.

There are all kinds of ways to do this – from buying limited partnership interests in oil drilling operations to outright ownership of Exxon-Mobile, Shell Oil and British Petroleum.

I’m not a fan of this approach for most people, except those with pretty big investment portfolios. Think, “millions,” not “thousands.”

For the rest of us who work for a living, you might look at buying some shares of exchange-traded funds, or ETFs, that are themselves tied to high oil or gas prices. Examples include the United States Gasoline Fund and the United States Heating Oil Fund (NYSE: UGA and UHN, respectively).

Neither of these funds concentrate on stocks – which are much harder to predict. Exxon Mobile could drive another tanker onto a rock tomorrow and have to pay a gazillion dollars in clean-up costs, negating the reason you bought the stock in the first place. That’s the deal, when you buy individual stocks – you take on all the company risks that can hit you out of nowhere.

These two ETFs, on the other hand, buy futures contracts on the commodities themselves. When fuel prices rise, so does the value of their shares.

So, in theory, when gas prices go up, you’re fine for a while. You can sell off a piece of your investment each month, and cover the higher gas prices. All it costs you is the commission on the purchase (you may need some help filing taxes next year, though, since these ETFs are structured as partnerships.

Other Hedges

Another way to protect yourself is to use a consumer price-hedging service, similar to Tomorrow’s Gas.  This service lets you buy “protection” against oil price spikes for 12 months at a time. If prices rise, each month, Tomorrow’s Gas adds money to your account to compensate. They send you a gas card, which you can use at the gas station of your choice.

If you’re a business owner, and you have a small fleet of vehicles, you can also hedge your exposure by using a service like FuelBank. This service allows you to hedge your exposure not just to gasoline, but also to diesel, jet fuel, marine diesel and aviation gasoline, as well as to natural gas. For $30 bucks, you protect yourself against price increases of more than $1.00 per gallon for up to 50 gallons per month. If fuel prices rise more than $1.00 gallon, they’ll pay you the difference.  You can also buy plans for 100, 200 or 500 gallons per month, too.

There’s an annual fee of $25 per customer, too, but this is regardless of how many vehicles you have in the fleet.

If you drive a lot, I’d suggest using one or more of these strategies. So if gas prices pop to $5 per gallon or more, you don’t have to worry. Better yet, you can brag to your friends.