Should You Bet on a Euro Squeeze Against the U.S. Dollar?

This has been a dismal year for the euro. The credit crisis continues unabated for the eurozone. Policies are talked about constantly without any real action provided. It seems as if there is no hope for the euro. This is best summarized when looking at the Commitments of Traders (COT) report, released by the Commodity Futures Trading Commission (CFTC). Currently, there are more bets against the euro than at any time since June 2010, which was also the low of that year for the currency, as investors soon rushed for the exits.

Should you bet on a euro squeeze against the U.S. dollar? Perhaps, but there might be other options. The eurozone is still an unstable and dangerous place to put your money. In fact, billions have been pouring out of the eurozone, as companies are unsure what will happen in the New Year. Let’s take a quick look at what might happen in 2012.

The eurozone just announced a new LTRO, Long Term Refinancing Operation. Essentially, this is created to increase liquidity in the system, a positive step if only for the short term. Then there is the possibility of Greece leaving the eurozone. On the whole, jettisoning the weakest nation would benefit the euro currency, although several big problems with Italy and Spain are left to be dealt with at a later time.

When you trade a currency, you are taking a bias on both sides; buying one currency and selling another. Instead of selling the U.S. dollar, perhaps you might look to Japan. This is a nation that has the highest debt/GDP ratio—at 230%—in the world, a budget deficit of 9.2%, and the central bank of which is committed to devaluing its currency in the hopes of increasing exports. On several metrics,Japan’s currency looks overbought, a condition caused by the flight to safety away from riskier currencies like the euro.

Both regions, Japan and the eurozone, have significant structural issues that need to be dealt with. Japan has demographic issues that can’t be fixed with a simple vote. The nation is getting older and not enough kids are being born to replace the population. In the short run, the yen has been used as a “safe” currency, to hide assets away from the instability of the eurozone. If investors sold a euro and bought yen, a short squeeze would mean that trade would be reversed. Yes, the U.S. dollar would also move, but when selling the other side of a currency, I would look to the weakest nation first, the one with the biggest problems.

The U.S.has a lot of problems, no question. But, as of today, it is still the reserve currency in the world. The Japanese yen is not. This is not a trade recommendation, but a variation to think about if the euro were to squeeze the bears. In the long run, the euro is in severe trouble. A short squeeze is not a long-term strategy; just one enacted due to an extreme position in the market.

The shocking thing to consider: currencies like the yen and U.S. dollar are backed by economies that are saddled with massive debts, yet they are considered safe. The world is running out of strong nations to invest in. Countries are racing to the bottom, trying to spend their way to economic prosperity, racking up huge debts and ultimately devaluing their currencies. In the end, it’s the citizens who lose, as the chaos that ensues causes uncertainty and ultimately a loss in purchasing power.

It’s either the frying pan or the fire; the choice is yours.

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