The euro fell to a one-year low versus the dollar as economic concerns about European Union member nations continue to mount.

The euro shed 0.6% to trade at $1.394 at 1:40 p.m. in New York yesterday (Thursday). Wednesday, the dollar reached as high as $1.3882, its highest level since Sept. 18, 2007, before dropping slightly to close at $1.3998, according to Bloomberg data.

“As Europe and even emerging economies struggle from the fallout of the subprime crisis, there is sentiment that the [United States] is doing relatively well compared with the rest of the world,” Saburo Matsumoto, chief foreign exchange strategist at Sumitomo Trust Bank, told AFP.

The euro’s slide versus the dollar and other major traded currencies, including the yen, came after a report from the European Commission that Germany, Spain and the United Kingdom could find themselves in a recession this year.

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Joaquín Almunia, the economics and monetary affairs commissioner for the Commission, described the current European economic environment as “difficult and uncertain,” The Financial Times reported.

The Commission downgraded its economic outlook projections for both the 27-country European Union and the 15-nation Eurozone whose members share the common euro currency. The EU forecast was lowered to 1.4% from 2.0%, while the Eurozone forecast was lowered to 1.3% from the 1.7% that had been predicted in April.

Germany, the EU’s largest economy, is expected to see a 0.2% contraction in gross domestic product (GDP) for the third quarter after a 0.5% contraction in the second quarter. Two consecutive quarters of economic contraction are the textbook definition of a recession.

The economies of the United Kingdom and Spain are expected to shrink in both the third and fourth quarters, while economic growth in France and Italy are expected to be flat.

Europe has been affected by the global credit crisis, as well as a slump in global consumer demand. Several countries, including the United Kingdom and Spain are grappling with housing recessions. But a weaker euro could prove to be a boost to European economies; much like the weak dollar stimulated U.S. exports.

The growing uncertainty about some of the Eurozone’s largest economies could cause the European Central Bank to reverse course and cut interest rates. Led by hawkish President Jean-Claude Trichet, the ECB voted to raise the key interest rate 25 basis points to its current level of 4.25% in July in an effort to fight rampant price inflation. Since that meeting the ECB’s monetary policy committee has voted to hold rates steady.

After the European Commission report, Trichet told the European parliament that the “current episode of weak economic growth is expected to be followed by a gradual recovery,” The Financial Times reported.

Trichet’s comments indicate he intends to stand firm on rates for now. ECB Vice President Lucas Papademos echoed Trichet’s comments at a press conference in Germany yesterday.

“There are indications that broad-based second-round effects are materializing and we want to make sure that they don’t become even broader and stronger,” Papademos told reporters in Hamburg, Bloomberg reported. “It’s not considered likely” that Eurozone GDP will shrink in the third quarter “but it can’t be excluded, taking into account uncertainty and downside risks,” he added.

Despite the ECB’s firm commitment to continue battling inflation, a Bloomberg survey of economists predicts that the ECB’s key rate will need to be reduced back to 4.0% within the first three months of 2009.

News and Related Story Links:

• Bloomberg News:
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• Bloomberg News:
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• The Financial Times:
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• AFP:
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• Money Morning:
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• Money Morning:
  ECB Holds Rates Steady, but Growth Concerns are Beginning to Supplant Fears About Inflation

By Jennifer Yousfi
Managing Editor

An unexpected increase in German business confidence sent the euro to a one-month high versus the dollar yesterday (Wednesday) on speculation that the European Central Bank could be forced to hike interest rates to combat inflation.

Germany’s Ifo Institute Business Climate Index increased to 103.5 in May from 102.4 in April. Economists had expected the index to decline to approximately 102.0.

“On the whole, the dampening of economic activity in Germany in the months following the very good first quarter should be moderate,” the institute said of the results, which were gathered from the polling of 7,000 German firms, The Associated Press reported.

Germany is the largest economy in the European Union and has so far proved fairly resistant to the global credit crunch and the surge in dollar-denominated commodities. With the German economy helping to fuel Eurozone growth, the ECB can turn its attention to consumer price inflation. The possibility of an interest rate increase to help curtail soaring prices pushed the euro higher against the greenback.

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The euro traded as high as $1.5765 as of 1:22 p.m. yesterday in New York, Bloomberg News reported, a 0.8% increase from the day prior and headed towards the euro’s all-time high of $1.6019, established April 22.

The ECB has remained hawkish on inflation, while the U.S. Federal Reserve, Fed Chairman Ben S. Bernanke and the central bank’s policymaking Federal Open Market Committee (FOMC) have chosen to focus on the weak U.S. economy and pursued an aggressive rate cutting campaign to try to spur economic activity. The dollar has suffered as a result.

The minutes from the FOMC’s April 29-30 meeting were released yesterday and indicated that the committee is still concerned by factors contributing to sluggish growth including the weak labor market, slowing consumer spending and continued lack of liquidity in the credit markets. Money Morning reported Monday that the Fed minutes were certain to be a key topic of conversation among economists this week.

The central bank committee that sets interest rates noted that “conditions across a number of financial markets were judged to have improved over the inter-meeting period, but financial markets remained fragile and strains in some markets had intensified.”

The FOMC voted to reduce the Fed funds rate by 25 basis points at its April meeting, but due to the “improved” conditions, many believe the Fed will hold rates steady at the next policymaking meeting slated for June 24 – 25.

The signal of a Fed pause led to a brief rally in the dollar after the release FOMC’s statement. However, a Fed that is holding rates steady is no match for an ECB that’s raising rates.

“The euro is heading back to $1.60,” Adam Boyton, a senior currency strategist at Deutsche Bank AG (DB) in New York told Bloomberg. “Interest-rate differential and high oil prices are supporting the euro.”

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Costumes with wide, padded shoulders, mindless soap operas about rich people and such [in retrospect] laughable musical acts as Culture Club and Boy George are 1980s routines that you likely abandoned a long time ago. But one routine from that decade – profiting from investments in Germany – is rediscovering its "glory days." And, unlike 80s-era pop music, the allure of investing in Germany is both rational and justifiable.

Germany has always had a strong economy, although investors there tended to lose out badly because of its regrettable tendency of invad ing neighboring countries. But after World War II, Germany was actually blessed with one of the better leaders of the 20th Century, a man who even 20 years ago had already been largely forgotten and whose name is today almost wholly unknown among younger Germans. The leader I’m referring to is Konrad Adenauer.

It’s both sad and unfair. Following, as he did, Germany’s most infamous leader, Adenauer has somehow been forgotten despite his many concrete achievements.

Indeed, Adenauer remained in power for 14 years [1949-63], and during that tenure slashed taxes, shredded the morass of often-pointless controls that [like many nations in Europe] had dragged down Germany’s post-war economy, and then presided over the "wirtschaftswunder" economic miracle that transformed the nation he led into the richest country in Europe – a position it had actually occupied before losing World War I.

B y the 1980s, everybody knew to invest in Germany.

Those "glory days" of the 1980s didn’t last as long as they could have or should have. Key leaders made some crucial mistakes, but the country’s real problems didn’t take hold until the 1990s. It started with the German reunification, which German leader Helmut Kohl foolishly carried out by equalizing the currencies of West and East Germany, making East German labor hopelessly uncompetitive. The result was 15 years of huge subsidies from West to East and a series of real estate disasters as Western construction companies overbuilt in the East.

Thus for several decades now, German growth has been pretty unimpressive. But there are signs that the country is returning to its former glories, with modest labor market reforms and tax cuts producing a more competitive nation. The costs of reunification have begun to decline – they were always likely to be a finite problem, as the Eastern education system was reformed and produced new, more productive workers – and the German growth rate has begun to increase. Notably, since the introduction of the euro in 1999, German labor competitiveness has increased by about 20% against rival European Union members, an outstanding showing. German companies have a healthy position in Eastern Europe, too, where economic growth has been rapid while wage growth remains far lower than in the West.

In a recent report, the IFO index of German business confidence rose to 104.2, a sign that the current 2.8% Gross Domestic Product (GDP) growth rate [equivalent on a per capita basis to a US rate of 3.8%, since Germany has zero population growth] is likely to continue. Only inflation, which has ticked up to 3%, is a problem, but the strong e uro should help that – while not doing much damage to Germany’s healthy balance of payments surplus.

So, what to buy? For a start, avoid the banks. There are too many banks in Germany, most of them propped up by their local governments. The banking system’s lack of good ideas for making money has recently been shown by two banks – IKB Deutsche Industriebank AG and Sachsen LB – that got in trouble by investing in U.S. subprime mortgages. Goodness knows what other U.S. problems are buried in German bank balance sheets, a product of enthusiastic U.S. salesmen and unimaginative German bank buyers. B est not to find out.

Instead, look to Germany’s great engineering companies. The largest, Siemens AG (SI), is still recovering from losses a couple of years ago and its stock price has been run up too high. However you might look at the electronics company Epcos AG (EPC). This was a spin-off from Siemens two decades ago, and now manufactures electronic components for the cell phone and tech industries worldwide, with factories in Europe, Asia and the Americas [so it is only moderately impacted by the strong e uro]. Its Price/Earnings ratio based on trailing earnings exceeds 14, but based on projected earnings is a very reasonable 10. You’re getting exposure to rapid growth – and at a very cheap price.

A second possibility is Fresenius Medical Care AG & Co. (FMS), the world’s largest manufacturer of kidney-dialysis machines, again a global company. This firm has a rather higher P/E ratio – about 23 times this year’s earnings – but its technological capability and strong market position create some attractive growth potential.

Finally, you can go to the telecommunications sector and try Deutsche Telekom AG (DT), which owns the U.S. wireless provider T- Mobile, which has enjoyed rapid growth in the American market. DT has had trouble recently because of declining landline revenue, but its mobile and Internet businesses are growing rapidly. I t currently sells at 20 times projected 2007 earnings, with earnings growth of around 12% forecast for 2008.

Investing in Germany might be coming back into fashion; it looks like a trend to follow.

News and Related Story Links:

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• Wikipedia:
  Helmut Kohl.

• Wikipedia:
  History of Germany.

• BruceSpringsteen.com:
  Glory Days.

Free-market U.S. conservatives like to talk about "old Europe." They tell stories about the sclerotic EU bureaucracy, the intransigent French unions, and the rigid German banking system.

Problem is, they ignore the really interesting Europe. The Europe that is growing rapidly. The Europe with soaring productivity, low inflation, small public sectors, an excellent education system, and high foreign investment in factories that quickly learn to undercut their neighbors in Western European.

This new Europe – centered around Poland, the Czech Republic, Slovakia and Hungary – is difficult for the average U.S. investor to buy. But there are still some inbound pathways with solid profit potential. Let me explain…

The Productive Key to Growth

As my readers in the Money Map Report know, productivity growth is the key to long-term gains. The United States manages productivity growth of just over 2% a year, Western Europe a little less, and Latin America an abysmally low 1% per annum.

At the opposite end of the spectrum, wealthy Asian countries like South Korea and Taiwan enjoy productivity growth of more than 4% a year. This makes their companies more competitive year by year against their Western counterparts.

Poland, Hungary, the Czech Republic and Slovakia are all quite wealthy – much wealthier than their neighbors further east. Yet each of their productivity growth rates over the last five years are almost up to Asian standards: Poland (3.1%); the Czech Republic (3.3%); Hungary (3.4%); and Slovakia (4.9%).

Real economic growth was also good in 2006, clocking in at 6.1% in Poland, 6.4% in the Czech Republic, and 8.3% in Slovakia.  Only Hungary (3.9%) was a little slower. Inflation, budgets, and balance of payments are all in balance or, at worst, are in a modest deficit.

The lower growth in Hungary illustrates the one remaining political problem in the region. Electorates in former Communist countries like to throw their governments out every few years. (I guess it’s partly the thrill of being able to do so after so many years under Communism.)

However, throwing one government out means putting another one in, and in all these countries, until now, the Socialists have been the replacement party. The Socialists are generally opposed to the free market, corrupt and full of survivors from the Communist regime.

That slows down economic progress, as it has in Hungary, where the Socialists have been back in power since 2002.

In Slovakia, the bad guys were in power until 1998, but were then succeeded by a wonderful reformist government under Mikulas Dzurinda that introduced a 19% flat tax and brought rapid economic growth. Alas, after the World Bank praised the Dzurinda government as the "best reformist government in the world," the Slovakian prime minister lost the 2006 election. So the country’s stellar growth in 2006 is likely to be the last such performance for some time to come.

Poland, at last, found a way around this progress blockade. In Sunday’s election, the ruling "social-conservative" Law-and-Justice government was thrown out – but wasn’t replaced by the Socialists, who got only 13% of the vote.

Instead, they were replaced by the "economic-conservative" Civic Platform. Since Law and Justice were themselves pretty competent economically, the Polish electorate can now enjoy the pleasure of throwing out its governments, while replacing them only with other governments equally committed to the free market and economic growth.

This is wonderful news for investors in Poland. And since these four countries tend to copy each other, it is likely to be wonderful news in the long run for investors in the other three countries, as well.

How to Play Emerging Europe

Since few stocks or American Depository Receipts (ADRs) are traded on the U.S. exchanges, the best bet for emerging Europe is the Spider Standard & Poor’s Emerging Europe (GUR) exchange-traded fund (ETF). It invests in the share indexes of the Czech Republic, Hungary, Poland, Russia and Turkey.

However this ETF was only founded in March, and currently has a market capitalization of only $39 million. That’s up from $29 million a month ago. Of the five countries I just listed, Turkey’s also a good bet (though it may hiccup from the Iraqi-Kurdistan problem). I would only be nervous of Russia.

There is also a closed-end fund, the $180 million Morgan Stanley Eastern Europe Fund (RNE), which trades at around net asset value. However, it has a high expense ratio of 1.6%, and invests mainly in Russia.

Mutual funds are usually for the risk averse. But in the case of the San Antonio, Tex.-based U.S. Global Investors Inc. (GROW), mutual funds are worth a look by conservative and aggressive investors alike. The reason: U.S. Global’s funds are almost always top performers. Their U.S. Global Accolade Eastern Europe Fund (EUROX) is no exception. You can invest in it with confidence.

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• Money Morning Investment Analysis:
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• Wikipedia:
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• Money Morning Investment Analysis:
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• Wikipedia:
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• Wikipedia:
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• Wikipedia:
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European Union finance ministers open two days of talks today (Monday) to discuss how key U.S. problems as a slowing economy, a super-weak dollar and a huge-and-growing trade deficit will affect the European Union, as well as the rest of the world economy.

The falling dollar has made U.S. exports cheaper versus European counterparts. Plus, Europe is feeling the pinch as its own key exports – French wine, Italian fashions and German sports cars – are being priced out of the affordability range of American consumers.

BusinessEurope, the employers federation, last week said that the euro has risen past the so-called "pain threshold" for European exporters by crossing the 1.40 to the dollar level. The group is also arguing that the euro is rising too fast against the Japanese Yen and the Chinese yuan.

With the United States problems, the EU has throttled back on its growth forecasts – from the prior 2.6% to the current projection of 2.5 growth for the months ahead.

The finance ministers of the 13 euro-zone nations will express their intense concern but will also contend that Europe is an "innocent victim" of others. They will say that the euro and that the euro-dollar exchange rate issue is part of a broader set of problems – China’s huge trade surplus and massive $1.33 trillion in foreign currency reserves and the United States’ huge runup in debt, both in its current account and fiscal budget deficits. Some sort of formalized plan is needed to undo, or at least mitigate, these problems and their impact on European businesses, as well as on the market as a whole.

Luxembourg’s prime minister, Jean-Claude Juncker, set the tone last week when he said the Europeans should not have to bear the consequences of other countries’ inaction.

Finance ministers from all 27 EU nations on Tuesday will lift a caution for London that was imposed when it ran a budget deficit above the EU’s recommended 3% of gross domestic product. The recent economic surge should allow Britain to cut that to 2.4% in the 2008-09 financial year – but only if it avoids a U.S.-like collapse of is super-heated housing sector, which some experts (including several here at Money Morning).

The Czech Republic will see its budget warning stepped up, as it is told to cut its deficit to zero within five years. This year, the deficit is likely to overrun a forecast of 3.3%, as it counts the cost of higher social welfare spending by the previous government. The country needs to get well below 3% to join the euro as Prague plans for 2012.

Since the euro was launched as a currency five years ago, Europe’s commission has tried to get the countries using the euro currency to work harder to slash budgets and to do more to coordinate economic activity. It says the euro has made the European market less vulnerable to outside shock, such as the big jump in oil and energy prices of the past year.

With the United States problems, the EU has throttled back on its growth forecasts – from the prior 2.6% to the current projection of 2.5 growth for the months ahead.

the possibilities of a worsening U.S. slowdown, higher oil prices and tighter borrowing conditions could all risk derailing Europe’s first bloom of growth after several years of stagnancy.

Related News and Story Links:

The Associated Press:
Finance Ministers Discuss Dollar Woes.

The European euro hit a record value of $1.39 this past week, and the Japanese yen strengthened again to 114 to the dollar, well above the 120 it’s traded at most of the year. The British pound Sterling is at $2.03, back to levels it hadn’t seen since 1980 or so.

For U.S. investors who are not planning a winter vacation in ever-more-expensive Europe, this may not appear to matter much.

However, it’s a trend that’s likely to continue, and it’s worth adjusting your portfolio to take advantage of it.

The Doleful Dollar

The dollar is likely to remain relatively weak for two reasons:

• First, the United States is still running a $700 billion balance-of-payments deficit with the rest of the world. Asian central banks have been financing this by purchasing Treasury bonds. Indeed, U.S debt comprises a nice chunk of China’s $1.33 trillion in foreign reserves. As we now know German regional banks have also been financing the shortfall by purchasing subprime mortgage debt. (It’s particularly good for the balance of payments when foreigners buy subprime mortgage debt, air-filled dot-coms, or the Brooklyn Bridge because the profit that domestic shysters make from selling worthless assets to foreigners counts as income). Nevertheless, both these trends are showing signs of ending. This means the United States has to export more, which means that the dollar has to drop against the euro, sterling, yen, renminbi and currency of anyone else who might be persuaded to buy U.S. products if they’re cheap enough.

• And, second, it looks like U.S. Federal Reserve Chairman Ben S. Bernanke will be cutting interest rates. Since the Bank of England, the European Central Bank (ECB), and the Bank of Japan (BOJ) all are closer to raising interest rates instead of cutting them, a Fed rate cut should make the dollar weak. That short-term factor explains the dollar’s current weakness; if Bernanke doesn’t cut rates next Tuesday, it may bounce back. (Unfortunately, if Fed policymakers opt to not cut interest rates, the U.S. stock market will probably fall out of bed).

Assuming you think this trend will continue, what should you be buying?

Currency and Fixed-Income Plays

One possibility is foreign currency itself, preferably in the form of deposits or short-term assets denominated in foreign currencies. However, remember that interest rates seem to be going up, so bonds should be approached with caution (when interest rates increase, those bonds that you bought will drop in market value from what you paid for them).

If your bank will allow you to make foreign currency deposits, that may be the simplest solution. You should avoid sterling, as Britain has many of the same problems (over-bubbly real estate market, too much financial services), though their problems haven’t advanced as far as our have – yet.

In terms of individual currencies, the euro and yen are probably the two best bets.

If you want to buy foreign currency bonds, you might consider a foreign currency bond fund (of which there aren’t very many available in the United States), such as the no-load T. Rowe Price International Bond Fund (RPIBX), which invests in high quality non-dollar-denominated bonds.

Two warnings:

• First, don’t buy bond funds investing in foreign junk bonds (because then you become like the sleepy and less-than-sharp German banks that invested in subprime mortgages – you don’t know what you’re getting).

• Second, don’t buy an emerging-markets bond fund, because emerging-markets bond portfolios, unlike stock portfolios, tend to be dominated by the countries with the most debt, which are consequently in most danger of defaulting.

There’s a second possibility. Don’t buy bonds. Buy stocks.

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Buy a Stake in the Leaders

The second possibility is to buy shares of U.S. companies with a lot of foreign business. These will benefit from a weak dollar in two ways:

• First, if they do business as local companies overseas, their assets and income in foreign countries will be worth more when translated back into dollars so that the company can consolidate its financial statements and report its performance to its U.S. shareholders.

• Second, if they export from the United States, their income will go up relative to their costs – a wonderful position to be in. There are lots of these companies. But the two of the best examples would be Coca Cola Co. (KO), which does business all over the world, and Boeing (BA), which is the United States’ largest exporter. Both stocks are currently trading at price-earnings ratios of over 20 – placing them on the pricey side – but the earnings going forward should be strong.

• Third, you can buy foreign company shares (avoiding companies exporting heavily to the United States, who suffer from a weak dollar just as Boeing benefits from it). Here you might as well benefit from rapid Asian growth. One possibility would be the streetTracks SmallCap Japan ETF (JSC) which invests in Japanese smaller (and, therefore, mostly domestic) companies. Another is SK Telecom (SKM), Korea’s largest cell-phone company, which has international operations in China, Vietnam and the United States, although the U.S. market is only a small part of its operations.

Probably a mix of strategies would work best. You shouldn’t turn your portfolio upside down to bet on a weak dollar, but you might as well make sure that some of your money is invested to benefit from it.

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