Dollar Rallies Against Euro — Flight to Quality
Kurt Brouwer September 30th, 2008
Source: St. Louis Federal Reserve
It was not long ago that pundits and currency prognosticators were predicting that the Euro would surpass the U.S. dollar as the world’s reserve currency. Of course, years ago other such pundits predicted the same thing for the Japanese yen and that never happened.
How does the Euro look in terms of surpassing the dollar as the world’s reserve currency? Not so good. During this credit crunch and financial crisis, it is revealing to see that the dollar is gaining value and the Euro is tumbling. The Euro’s high point was almost $1.60 to one Euro. This chart from the St. Louis Federal Reserve actually understates the movement because today, it takes $1.40 dollars to buy one Euro. That’s still far from the dollar’s strongest point which was in 2001 when it took 84 cents to buy one Euro, but the trend is moving towards the dollar as this piece from Bloomberg [emphasis added] illustrates:
Euro Falls Most Against Dollar Amid European Banking Failures (Bloomberg, September 30, 2008, Daniel Kruger and Ye Xie)
The euro fell the most against the dollar since the introduction of the shared currency in 1999 after France and Belgium led a state-backed rescue of Dexia SA, as the widening financial crisis forces governments to prop up financial institutions across Europe.
…The euro fell 2.5 percent to $1.4081 at 3:51 p.m. in New York, from $1.4434 yesterday. The euro also slid to 149.74 yen from 150.38. It earlier reached 148.55, the weakest since Sept. 16. The yen weakened to 106.43 per dollar from 104.18, after earlier reaching 103.54, also the most since Sept. 16.
…”There is a mad scramble for U.S. dollar funding demand from a global U.S. dollar-based financial system,” said Claudio Piron, Singapore-based head of Asian currency research at JPMorgan Chase & Co, the second-biggest U.S. bank by market value…
I don’t want to make too much of this currency movement because it reflects lots of short-term uncertainty and volatility and when things ease up a bit, we may see a move back in the other direction. Yet, it still must be noted that when things get tough, the world flocks to the U.S. dollar.
Why? Safety. Liquidity. The rule of law. Despite a Congress that acts like a bunch of spoiled children, investors want the dollar because they believe their money is safer here than in Europe or elsewhere. Maybe Americans should take some comfort in knowing this.
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Dollars lost their value because we flood the world with them by our trade deficit (there was an excess supply of dollars). Oil is priced in dollars so to get the same value of oil you had to come up with more dollars. Oil rose (cost more dollars per barrell) because the dollar fell.
Now that a recession seems likely because of the economic consequences of the banking log jam, the expectation is that demand for oil will go down.
So, oil is now less valueable and you can get a barrell with fewer dollars thus the dollar is going up.
The strength of the dollar has nothing to do with the strentgh or safety of the american economy. It is a consequence of expectations of a slowdown in the american economy.
You’re right that a strong dollar does not necessarily imply a strong economy. For example, the dollar was far stronger in 2001 than in 2006. Yet, the economy was much better in 2006 than in 2001.
The increase in the dollar lately has to do with the Fed Funds rate, which has remained stable for several months at 2%. It also has to do with the fact that foreign investors want to buy U.S. Treasury securities.
If you want more information on the correlation between the dollar and Fed Funds’ rates, see How Far Has the Dollar Fallen? And Why? — What’s Next?
Kurt, despite the losses to my 401K, and your mutual fund business, some very profound things happened yesterday with the rejection of the Bailout:
1. For the last 9 or so years, we’ve seen politicians and media trumpet what I call the Big Shiny Thing (Dot.com Bubble, Housing Bubble, Iraq War, Prescription Drug bill are prominent examples). They’ve promoted the Big Shiny Thing so heavily that people were led to believe it was the Only Thing between us and uncomfortable things happening to us. The American people, through such reps as Dennis Kucinich and Jeb Hensarling, called “bullfeathers” on the Bailout panic-button pushing. Even though a bailout in the same form will likely pass by Saturday, that decision on Monday cannot be reversed.
2. The GOP House, as petulant as some of them sounded after the vote, sent a message to everyone that they can’t be expected to swallow “crap sandwiches” REGARDLESS of actions they take. They finally stood up for themselves, so to speak. Unfortunately, it came in the service of a perceived financial crisis.
3. The 777 point drop in the Dow did something to the American people: it concentrated the mind on getting action passed. Let’s face it: Trying to explain how bad a 3.04 TED Spread (as of today) is to a citizen that is having to utilize 15% interest rate credit cards will always strain credulity. But let the Dow go down big after a crucial vote, and watch the calls go from against the bailout to FOR it instantly! Ask Rep. Joe Barton (R-TX).
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Exactly right Brad. It depends, as an old saying goes, on whose ox is being gored [no pun intended]. I think we will see a financial rescue package that passes roughly along the lines proposed in the Senate today. In their defense, representatives in the House are closer to voters than other elected officials.
Both Dems and Reps in the House were petulant though. So, one good outcome out of all this is that we have been reminded how self-centered politicians are.