For the last month I have been travelling through Europe and I am always surprised at how beautiful that part of the world is, however this time I was also surprised by the painful strength of the Euro. In some countries, what used to be a good price for food, lodging, and products has now become an extravagance. What was interesting was that depending on what country I was in, Europeans viewed the health of the European economy differently, and this is one of the fundamental issues the EU is facing right now. When the EU has to balance political interests and economic needs with countries like Germany, the U.K., along with sputtering economies like Spain, Italy, Portugal, Greece, and France, the European Central Bank (ECB) finds itself with a big dilemma. One thing that is clear is that the U.S. Federal Reserve (FED) and the ECB are both running into a stagflation type scenario. For those of you that aren't familiar with stagflation, it is a period of inflation combined with stagnation, meaning slow economic growth with rising unemployment. The last time there was global stagflation was in the 1970's during the last oil crisis. Coincidence?
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Don't fool yourself. The word stagflation started getting brought up again about this time last year, and in the last 12 months the FED has made historical moves to try to prevent it and stop a recession with rate cuts and other drastic measures. The positive results of these moves are still not showing up and unfortunately inflation is starting to creep up. Europe on the other hand hasn't played all of its cards and is in a situation where it needs to do something like start printing more money or reduce interest rates to keep the economy going. However, the side effect of this is that these moves will weaken the Euro and therefore cause prices to rise; hence inflation. We could discuss this for another 10 pages, but many analysts are starting to concur that the only direction the Euro can go is down. This is because either the ECB will take measures that will either devalue the Euro, or by not acting the economy will start slowing down which will also devalue the Euro. Couple this with the fact that Chinese and Indian investors are starting to invest more in their own countries, therefore pulling out more dollars from European and U.S. treasuries. There is also additional political pressure with the recent rejection by Ireland of the Treaty of Lisbon. This rejection has reinforced the concern that there can be no economic integration unless the countries are actually politically integrated. Put this all together and the Euro loses a touch of its sheen. In fact, many analysts are calling for the Euro to be on par with the dollar within the next five years.
So now that I have made my case for the euro to fall long term, what opportunities exist in U.S. investing for an investor that is holding Euros? An investor that is holding Euros has an opportunity for a dual effect of making a return on a U.S. dollar investment and also reaping the benefits of a contracting currency spread. As an example, if you converted 100,000 Euros to U.S. dollars you would end up with about U.S. $155,000. If you took that $155,000 and invested it for the next 3 years at a 7% compounded return, you would end up with about $190,000. If the investment returned 9% compounded, it would give you just over $200,000. Then, if we saw the Euro come down 20% over the next 3 years against the dollar and converted our $190,000 back into Euros, we would have ¬146,680. All in all our 7% investment return would yield 유로247 a profit after the exchange of ¬46,000, or 15.5%. Our 9% return would yield a profit of ¬54,400, or 18%. In both cases by exchanging Euros for a U.S. dollar investment the net effect of the exchange doubles the expected rate of return.
The only way for the above scenario to work is to assure that the investment you choose will be one that provides a steady return, such as investment income that can be re-invested, and that the investment also is structured to protect the principal. Without these two important ingredients the above investment scenario will be in vain. Also, receiving the return as investment income that is paid either quarterly or semi-annually will give the risk adverse investor the ability to convert the currency on the way down.
All of the above is important to keep in mind when compared to investing Euros within Europe. Some investors may be thinking that Europe is insulated from what is happening in the U.S. and there is too much risk involved with U.S. investing for steady investment income and a capital gain after conversion. What has become clear is that globalization has made the world smaller, interdependent, and the laws of cause and effect are playing out from one side of the globe to the other. It is important to not underestimate how Europe is starting to feel the effects of the U.S. situation. Many of my colleagues in Europe are reporting that mortgages are becoming more difficult to obtain as the affects of the U.S. credit crisis have also tightened lending standards abroad. The only major difference so far is that, unlike the U.S. where housing fell off a peak, the European real estate market seems to have instead hit a plateau. This will hopefully create a basis for a cyclical slowdown in Europe instead of a bubble bursting like the U.S. I think it would be hard to find detractors that the world, its economy, and the system that is driving it all are changing. If we don't change our investing mindset with it, we risk becoming the typewriter in a computer world
In these unpredictable financial times, the value of currency is fluctuating more than ever before so it seems. How does a currency falling against others' affect business, and people's lives, in general? Let's take a look at one example, the British pound, to see who wins - and who loses, as the pound falls against other major currencies.
Sterling has lost 20% of it's value in the last year. The pound has fallen to a record low against the euro to 1.1499 euros. The two currencies could soon reach parity for the first time.
The two major reasons for sterling's loss of value is firstly because as interest rates in the UK drop, investors elsewhere pull their money out to seek higher returns in other currencies. It's the same as small investors seeking a higher return by moving their money out of one bank into another. With foreign investors though it's often on a much larger scale. As that happens, the value of sterling spirals downwards. The second reason is that there is also a loss of confidence triggered by the Bank of England repeatedly slashing interest rates.
Who loses out then when the pound falls?
It's bad for British tourists going abroad. They have to pay more for their foreign currency. If, for example, at one time they would have received 300 euros for £200, now they will only get 230 euros for the same £200 (using the rate quoted above). If they still want their 300 euros they would need to hand over £260.89, thus costing an extra £60.89. That's not taking into consideration any commissions or other charges which might be payable.
It's bad for importers because goods they buy abroad cost more. They have to hand over more in pounds to buy the products or services. The same goes for anyone in the UK who pays wages to someone abroad for any work done, if the agreement is that the employee will be paid in their own currency.
But, there are some winners in all of this.
Businesses that export their goods to Europe will be happy with this situation. If they are paid, say in euros, when they convert to sterling the value of that money will be higher than it was previously. An example of this was on the news recently, when the owner of a Company buying old taxis and refurbishing them to sell to Germany, Holland, Australia, the US etc was interviewed. His business is doing rather well, despite the shrinking UK market as the worsening economy deepens.
If a worker in the UK gets paid in foreign currency that's also good. He will receive more in pounds when it is exchanged to sterling. It's also good for foreign tourists coming to UK. They pay less for pounds, so it encourages them to come here, which of course all helps the UK economy. A high pound tends to deter some from visiting.
No doubt the speculators will win and lose in the currency markets, but for the ordinary person on the street whether they end up in one camp or the other will depend on a number of factors. Sadly, some companies may go bankrupt which will certainly affect their workers who have no control over the value of their country's currency.