How I’m going to play the eurozone end game
Nobody knows how the eurozone debt crisis will end. But one possibility is the break-up of the euro into strong and weak currencies. Bengt Saelensminde explains one way to hedge your wealth against a eurozone meltdown.
I'll be honest. This situation in Europe is giving me cause for concern.
You see, I hold a fair chunk of my wealth in eurozone property. I have a place in France that I spend a fair amount of my time in. I plan to own that for a long time, so no worries there.
But I plan to sell some of my French properties in due course and that means that I've got considerable euro exposure. Now that there's a very real chance of a total break-up of the eurozone I feel it's time to take action.
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So I've been thinking about how to hedge my position. And I've found an interesting way to play a potential eurozone break up.
Let me show you what I'm thinking.
Profit from the eurozone split
For the last few years the euro has shown tremendous strength. Germany's policy of guiding the European Central Bank(ECB) with Bundesbank-like discipline may not be what the weaker states wanted, but it's certainly garnered the faith of the markets.
But how long can the euro's strength last? The strength of the euro undoubtedly comes from Germany's backing. The key concern is that if Germany feels it's bailing out the weaker states, thenit may decide to leave the euro. The euro left behind is likely to crash in value.
To my mind, a German euro is not worth the same as a Greek one; nor a Portuguese, nor aFrench one for that matter. And if the eurozone does break up, those weaker countries are going to get hit. That would be bad news for my French investment.
So I want to swap my French euro exposure for German euro exposure. I want to short the French euro (as that's where my properties are) and I want to put it into German euros. And right now I can do so at an exchange rate of 1:1.
If Germany ends up walking away from the euro and my French euro holdings crash then at least I'll have some insurance in place.
How to short something that doesn't yet exist!
If you've got money in a euro bank account, then you can say you are long' the euro. If the euro strengthens, then you make money. That's pretty straightforward. But what you may not have considered before is that if you take a euro loan, then you are effectively short' the euro. You can profit if it goes down.
If I borrow euros against my French assets and then place the money in a German bank account, then I'm short' French and long' German euros. And because they're worth the same (for the moment), I'm net neutral.
I don't pretend to know how all this is going to play out in Europe.
Some pundits suggest there'll be a northern and southern euro. Others say it'll be a core euro and a deutschmark, and then the peripheral pariahs: escudo, drachma, peseta, lira, etc.
But here's the point: I just can't see any conceivable scenario where the currency in which Germany is involved isn't stronger than whatever it leaves behind. I'm gambling that one day, there'll be a big difference between the two. If things get really bad in Europe, I could end up making money or at least shielding my investment.
Here are the figures
I've just been looking at the Crdit Agricole (Switzerland) website. It's offering mortgages for French property at fixed rates of interest as follows:
| 3 years | 1.90% |
| 5 years | 2.25% |
| 7 years | 2.60% |
| 10 years | 2.90% |
| 15 years | 3.15% |
Just look at what Crdit Agricole is offering. Less than 3% for ten years and a trifling (well it seems trifling to me) 3.15% for 15 years!
My plan? Well, I'm looking to borrow about a third of the value of my properties with Crdit Agricole on a 15-year loan. Then I'm going to re-invest the funds in Germany. Remember, I'm getting one German euro for every French one I "short". And that's not a deal I expect to be on offer forever.
For the moment, I'll leave the German euros on deposit. Sure, I'll get taxed on any income. But then again, I can now claim the interest on the French loan against my income on my French properties.
A few risks to consider
Inevitably there are transaction costs involved with what I'm proposing here. But the costs won't be onerous. I'll be paying out a few thousand in arrangement fees and I'll also have to take out a life assurance policy.
And this strategy may leave me vulnerable to a German bank default. Arguably leaving the equity in the French property is safer than entrusting the cash to a bank even a German one!
That said, what I'm playing for is a potential 20% to 40% currency revaluation. My short Latin euro, long Germanic euro' is designed to provide a hedge against a euro split.
None of us knows for sure what the eurozone endgame will be. For all I know, it may just muddle along in its present format for another 15 years. And if it does, then there'll be no profit in this trade.
But at least there won't be a loss either, well apart from arrangement fees and tax. And for me, that's going to help me sleep a little easier as this eurozone crisis unfolds.
Long-time readers will know that I'm not a big fan of debt. But as you can see, there are occasions when it could work to your advantage. In this case, a loan can provide a useful way of shorting a currency. Even when that currency has yet to be created!
This article is taken from the free investment email The Right side. Sign up to The Right Side here.
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Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.
He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.
Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.