How to Play the Collapse of the Euro: DRR

by Alexander Green, Investment U’s Chief Investment Strategist
Thursday, July 28, 2011: Issue #1566

The Eurozone is a sight to behold.

Economic growth is anemic. Greece is careening toward default on its sovereign debt. Ireland, Italy, Portugal and Spain may not be far behind. The break-up of the currency block can’t be ruled out.

And yet … the currency is up seven percent against the dollar this year, to over $1.40. How long can this gravity-defying feat continue?

Not indefinitely. Understand that the rise in the euro against the dollar is, in part, a reflection of our own economic and political woes here at home. The Swiss franc, for instance, is up 16 percent against the dollar year to date and more than 30 percent over the past year. (And Switzerland, a landlocked nation with a smaller population than New York City, is hardly an economic powerhouse.)

Yet economic and political problems in the Eurozone are much more severe than they are here. Debt as a percentage of GDP is higher in many countries. There are no good political solutions. In the months ahead, boatloads of money will be made betting against the euro…

The Eurozone’s Debt-Disaster Continues

Richer Eurozone countries like Germany and France are tired of bailing out their more profligate brethren. The citizens of weaker countries are angry that monetary policy has been outsourced to Frankfurt and their governments are being forced to adopt harsh austerity measures.

In Spain, for instance, unemployment is 21 percent. The typical Spaniard would love to see the local currency devalued to increase the attractiveness of its exports and seaside resorts. But the peseta is long gone – and so are any opportunities to manipulate fiscal and monetary measures to kick-start the Spanish economy.

Even more ominous, there’s no mechanism in place for any of these weaker countries to leave the Eurozone. Even if Greece could drop out, for instance, it would be a disaster for that country. Its debts would have to be re-denominated in a new currency, causing interest rates to skyrocket, deficits to worsen and economic growth to crumble. And since European banks own huge amounts of Greek debt, the chaos would only spread.

This is what it means to be stuck between a rock and a hard place.

Greek citizens are angry that other countries are dictating their domestic policies. This is equally true for the other weak sisters in the Eurozone. Many of them chafe at the idea of staying and yet can’t imagine leaving, either.

Given this structural problem, the likelihood is that the euro will fall substantially in the weeks and months ahead and perhaps trade at parity with the dollar, as it did in the 90s.

How Do You Play the Collapse of the Euro?

Personally, I think it’s far too risky to bet against the euro with futures and options. Far superior, in my view, is an exchange-traded fund (ETF) that bets against the euro: Market Vectors Double Short Euro ETN (NYSE: DRR).

This fund is double short the euro. That means if the euro falls 15 percent, the fund will appreciate approximately 30 percent. The reverse is also true, of course. But the problems in the Eurozone are not going away any time soon. It’s tough to imagine the euro staging much of a rally from here.

Far more likely is that the euro will slide as problems in this part of the world worsen. And that will be good news for holders of this double-short ETF.