A way to play rising taxes and a dollar correction

It took three speeding tickets in the south of France on the way from Monaco to Barcelona, but we made it to Spain late yesterday evening.  I had forgotten how expensive it is to drive in France. Fuel is among the most expensive in Europe thanks to a series of extraordinarily high taxes.

Gasoline, as people often forget, is a fungible commodity… in its pure form it should cost the same everywhere because it is priced by the market and traded on futures exchanges.

Aside from some variations in distribution costs, the major reason why fuel is priced differently around the world is government meddling– some governments subsidize fuel so that it’s artificially cheap (Venezuela, Dubai); others tax it to death (France, California).

It’s no secret that western European governments enforce an incredibly high tax burden on their citizens in order to pay for the ‘greater good’ of all members of society.  Taxes, as we are all aware, eventually lead to higher prices.  In this case, I’ve been actually shocked… even offended, at the prices of what I have seen in Europe.

After a series of tax increases over the last 2-years to pay for the effects of the economic slowdown, Europe has become much more expensive than I remember even six-months ago. I spend a few months on the continent each year and have a good feel for pricing; it seems to me that things are starting to get out of control.

$82.50 for two burgers and three beers; $13.50 for a fast food sandwich; $7 for a cup of coffee; $4 for a small pack of gum at a gas station. You get the idea.

Part of this pricing scheme is clearly based on recent dollar weakness. Much of the world’s institutional capital has lost confidence in the dollar simply due to the prospect of an extended period of ultra-low interest rates.

Last Friday’s jobs report gave the market a brief period of confidence in the dollar– investors believed that the US economy had reached a turning point, meaning that interest rates would rise earlier than expected.  Interest rate futures soared, and investors ran back into the dollar.

This only lasted briefly, for as soon as Comrade Bernanke opened his mouth on Monday, he assured markets that he would continue to keep interest rates artificially low. And just as quickly as they piled in to the dollar, investors went looking for the exit once again.

There are only three currencies in the world that have the ability to absorb enormous capital flows like this– the dollar, the euro, and the yen.  When investors flee the dollar and are looking to park their capital, it goes to the yen first, and then the euro. As such, there has been a steady rise in both of these currencies this year.

The price disparity that has developed between Europe and the United States, though, is enormous… and the exchange rate only tells part of the story.

In economics, the “law of one price” suggests that, everything else being equal, identical goods should be priced the same everywhere in the world– an iPod in Paris should cost the same as an iPod in New York. 

But everything else is not equal.

In Europe, merchants are plagued by higher taxes across the board– sales (VAT) taxes, payroll taxes, income taxes, excise fees, and a variety of others. All of these taxes are eventually baked into a higher price for products, and the consumer is the one who ultimately pays.

This is simply another form of inflation. Taxes push up the price of goods, employees demand commensurate wage increases, and the price of everything increases… yet there has been no real wealth created.

It is for this reason that I see two things happening;

First, the euro is due for a fall against the dollar. Yes, investors view the dollar as risky, but as the worthless ratings agencies are circling over Greece for a downgrade, investors also view the euro as risky. This reduces demand for the euro, and as there are few options available to absorb large currency flows, the dollar stands to gain.

Besides, in the long run, prices need to be similar, and that means a currency correction… leading me to point #2:

It’s not that the euro is terribly overpriced; it’s that the dollar is significantly underpriced, relative to ‘stuff’.  iPods and apple pie should all cost more in the United States, and they will.  The next round of new taxes to pay for carbon, health care, etc. will cause European-style price inflation as US merchants have to increase the price of ‘stuff’ to keep up with taxes.

End result? The euro falls against the dollar, and the dollar falls against ‘stuff’.  You can play a euro/dollar short, but I think it would be an even better trade to short the euro against gold and silver.

More on this later.

About the Author

Simon Black is an international investor, entrepreneur, and founder of Sovereign Man. His free daily e-letter Notes from the Field is about using the experiences from his life and travels to help you achieve more freedom, make more money, keep more of it, and protect it all from bankrupt governments.