Currency buyers suffer from King Lear’s problem

March 1, 2010

Currency buyers are suffering from King Lear’s dilemma. Shakespeare’s monarch could not decide which of his two ungrateful daughters was less awful. What looked like a bad deal from one, permission to stay with 50 knights, suddenly seemed attractive when her sister’s alternative was a mere 25.

Trading floors may not echo with Lear’s desperate words — “when others are more wicked, not being the worst stands in some rank of praise” — but foreign-exchange dealers know the feeling.

Only a few weeks ago, they were mostly worrying that the mix of huge U.S. fiscal deficits, political gridlock and tepid economic recovery would undermine the dollar. The euro, by comparison, looked less awful. The region’s sluggish recovery and expensive currency in terms of relative prices were offset by a positive trade balance and signs of fiscal discipline.

But then the woes in Greece and other weak euro zone members came to the fore. FX traders began listening to the euro-sceptics who had long been predicting the single currency would split. Big bets were placed against the euro, while the United States, for all its long-term weaknesses, looked a safer place to spend a few weeks.

Lear had only two wicked daughters, Goneril and Regan. But there are more ugly sisters in the currency world. The pound still counts as a major currency, though maybe not for long if fears of a fiscal crisis — think huge deficits and a hung parliament in the upcoming election — become self-fulfilling. Since Feb. 15, sterling has fallen 2 percent against the weak euro.

For now, the yen could most resemble Cordelia, Lear’s virtuous daughter. Japan, however, seems locked in permanent recession and some currency gurus say the over-indebted government will inevitably meet a disastrous end.

King Lear eventually was driven to madness by his “unkind daughters”. Currency traders generally welcome the volatility generated by rotating fears. It would be foolish to assume the worst news will continue to come out of Athens. There are enough problems around the world that the euro’s time as the ugliest princess is likely to be brief.

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