What No One Tells You About Currency

James Juliano Insights

Financial media reports the Dollar is reaching “radical” highs while the Euro “crashes.”  The problem is that most of what is being said is misleading or just plain wrong. Let’s examine what is really going on in the US$ and Euro.

Headlines proclaim that the US$ is screaming higher as the Euro crashes. These reports refer to the cross rate between the two currencies. Cross rates measure the relative prices of any two global currencies. The chart below shows the cross rate between the US$ and Euro, and measures how many US dollars it takes to buy one Euro. It currently takes 1.0557 US dollars to purchase 1 Euro. As the chart shows, that ratio was as high 1.39 last April, and the rapid decline in the ratio is prompting news that the Euro is “crashing” while the US$ “radically” strengthens.

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The problem is that measuring with the wrong tool leads to wrong assessments, and cross currency rates are the wrong tool. Cross rates are limited by the fact they are a ratio. When a ratio moves it is impossible to tell which component is driving the change. When the cross rate falls from 1.39 to 1.05 we cannot tell if the US$ has strengthened, the Euro has weakened or both. To see the truth, we must look independently at the values of each currency measured against smething with a stable value, like gold.

Gold’s value is stable over time, so when we look at gold prices in terms of any currency we can view how that currency’s value changes. When viewing a gold chart we are not seeing the price of gold move around, rather we are seeing the value of the currency being priced in gold move around. When the gold price of a currency rises, that currency is losing value. When the gold price of a currency falls, that currency is gaining value. Whether a currency is gaining or losing value is extremely important. The value of a country’s currency can be seen as a simple scorecard of that country’s economic policy landscape. Good policies help strengthen a currency, while bad policies destroy a currency’s value. In a feedback loop, strong and stable currencies act as magnets for global capital which seeks the predictability and return opportunities created by the policy landscape in place. In contrast, weak currencies repel global capital, which seeks a safe haven or inflation hedge away from the declining real value of assets in that country. Let’s look at the real values of the US$ and Euro in gold terms over short and long timeframes to reveal what is actually happening.

US Dollar

The US$ is not “radically” strong. In the short term, the US$ is only slightly stronger than average levels over the past eighteen months. The US has been stabilizing between $1200-$1300/oz and only recently strengthened out of that “box.” US$ gold prices were actually lower as recently as Nov 2014 and there were no headlines then about a “radically” strong US$. Looking longer term it becomes even harder to see recent US$ strength as a problem. Gold prices in US$ have a long way to fall for the US$ to regain some of the value it lost this decade. It is not unreasonable for gold to fall (US$ to strengthen) back to $600-$900/oz.  This would be a very good thing for the US economy and US assets. Remember, gold prices fell (US$ strengthened) over 25% in 2013. There were no fearful headlines about a US$ that was strengthening too far too fast. US equity prices rose over 30% that year.

US$ Short Term – 2 Years

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US$ Long Term – 12 Years

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Euro

The Euro is not really “crashing.” In the short term, the Euro had been stabilizing around E950/oz and only recently weakened outside of that “box.” The Euro is not even as weak as it was a month ago. Looking longer term, the Euro is far from as weak as it was back in 2011-12 when Euro gold was near E1400/oz.

 

Euro Short Term – 2 Years

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Euro Long Term –  12 Years

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Despite the panicked headlines about currencies crashing or strengthening too fast, we see the truth when using a better lens. The US$ is gradually strengthening again after a dramatic strengthening in 2013. There is a long way to go to unwind the US$ devaluation from 2002-2012. The Euro was similarly strong and stabilizing until very recently. Recent Euro weakness is a shot across the bow warning of European policy mistakes, but in no way is the Euro “crashing.” The Euro is stronger than just a month ago and dramatically stronger than in 2012. Things may get worse in Euroland and the Euro could actually crash, but the Euro is not currently sliding into oblivion. Panicked headlines proclaiming this is happening now are as misleading as looking at currency cross rates to begin with.

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