Should we care about euro/dollar?

By Felix Salmon
December 14, 2011
lot of chatter right now about the euro, which is now worth less than $1.30.

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There’s a lot of chatter right now about the euro, which is now worth less than $1.30. That’s a reasonably big fall: it was as high as 1.3385 on Monday. But it’s worth keeping things in perspective. Here’s a five-year chart of EURUSD, or the value of one euro in dollars:

eurusd.tiff

The main thing to notice here is the volatility: we’re basically back to exactly where we were five years ago, but we’ve had a very bumpy ride along the way. Going forwards, it seems sensible to expect that there will be more of the same: currencies going up and down in a fundamentally unpredictable manner.

The second thing to notice is how tiny a move from 1.33 to 1.29 really is, in the grand scheme of things. Is EURUSD volatile right now? Yes — but it’s been this volatile for years. There’s really nothing new or different or important going on.

The third thing worth noticing is that news reports nearly always talk in terms of currencies weakening rather than strengthening. If EURUSD goes down, then that’s always a reaction to the latest eurocrisis, whatever it might be. On the other hand, if EURUSD goes up, that’s never taken as a sign of strength in Europe: instead, we get bombarded by stories about the weak dollar, normally accompanied by doom-laden prognostications about the US economy.

For all that it’s a tempting narrative, however, currency moves should not be taken as some kind of market referendum on the health of a given economy. In the Wall Street Journal, Richard Barley has ventured that “the euro may now have become the main indicator of the depth of the currency bloc’s crisis” — but in truth there’s no good reason that should be the case. And it’s an unprovable assertion, too: the minute that the euro rises as the crisis gets worse, Barley can simply declare that something else has replaced it as the indicator to look at.

Let’s say that the eurozone is going to fracture, with weaker countries like Greece leaving the currency and returning to the drachma. Would that be good or bad for the value of the euro? It’s hard to tell. The rump eurozone would be stronger, and currencies can do pretty well during a crisis, depending on how the central bank reacts. After all, in the short term, currency flows are largely a function of interest rates, which are set by central banks: money goes to where it can earn the most interest.

And in the longer term, no one really has a clue what might happen. Four years ago, Bloomberg caused a global stir when it reported that supermodel Gisele Bundchen was insisting on being paid in euros, on the grounds that the dollar was simply a bad bet. The value of the euro back then? $1.45. And of course Bundchen looked smart, for a while — until the euro fell off a cliff a few months later.

Right now, there are similar stories doing the rounds about Metallica, who are reportedly bearish on the euro. They, too, are likely to look smart until they look stupid.

The main thing to remember here is that the European Union is still an economic powerhouse, with 27 countries pumping out trillions of dollars’ worth of domestic product every year. All those goods and services are worth real money, no matter what happens to the political union. And the European Central Bank is incredibly reluctant to print money, which means that the chances of the euro being eroded by inflation are even lower than the chances of the same thing happening to the dollar.

For the foreseeable future, then, we can expect the euro to rise and fall in its now-standard pattern of unpredictable volatility. If a period of the euro falling happens to coincide with a period of especial crisis in the eurozone, then we can also expect a spate of stories extracting spurious causation from a random correlation. And similarly, if a period of the euro rising happens to coincide with bad economic data in the US, then we’ll all be told that the dollar is weakening on a deteriorating growth outlook.

What does this mean for the 99.9% of us who don’t play the currency markets? If you’re an international traveler, then visiting Europe just got a bit cheaper. If you’re not, then you can probably ignore currency rates altogether. And if you’re concerned that the crisis in Europe is going to tip the world into another global recession, then if I were you I’d look at European interbank lending rates and sovereign debt yields to get an indication of how bad things are. The euro/dollar exchange rate is just too noisy to be able to tell you much of anything.

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Comments
9 comments so far

Imagine if rates paid by US governmnt to borrow were not as low as they are right now in no small part due to capital flight from Europe debt/Euro. How would that change economic growth in US? Answer: not in a positive way. US obtained this benefit right as QE2 ended.

Posted by tgriffin | Report as abusive

Imagine if rates paid by US governmnt to borrow were not as low as they are right now in no small part due to capital flight from Europe debt/Euro. How would that change economic growth in US? Answer: not in a positive way. US obtained this benefit right as QE2 ended.

Posted by tgriffin | Report as abusive

GET ME REWRITE

Four years ago, Bloomberg caused a global stir when it REPEATED A FALSE STORY FROM THE BRAZILIAN MEDIA that supermodel Gisele Bundchen was insisting on being paid in euros, on the grounds that the dollar was simply a bad bet. The value of the euro back then? $1.45. And of course Bundchen looked smart, for a while — WHEN HER PUBLICIST REPUDIATED THE FALSE STORY.

Posted by johnhhaskell | Report as abusive

Gisele’s manager (who also happens to be her sister) is now denying those reports, insisting the claims are “ridiculous”.

Patricia says, “It’s a joke by some journalist, it’s ridiculous. I never said that to any press organization. We never talk about Gisele’s contracts, and even less so the money involved.

“(Gisele) is continuing to sign her contracts in dollars or euros, as she has always done. She is bemused by these reactions. This information is not true … I do not recall ever having said anything that could be interpreted in that way.”

Posted by johnhhaskell | Report as abusive

The Bundchen Index? New rival for the VIX?

Anyway, just wanted to say “agreed, Salmon”, humble two cents and all that.

Posted by ottorock | Report as abusive

it just means, that we are going back to “normal”,
kinda like “fair value” which would be around 1.21-1.25 $/€
depending on whom you ask,
see http://www.slideshare.net/genauer/curren cies

Posted by genauer | Report as abusive

Most likely could agree with all the reasons as mentioned above as well as in the article. Am Bearish on the Euro for quite some time now and hope trading this market short will get it right. However from a technical point of view I haven´t seen any comentary on basic chart analysis of this long term chart. In my opinion we are seeing a Triple Top High long term with on top of that in medium term a clear Shoulder Head Shoulder formation. So in both cases this is a negative sign for which 1.25 / 1.2470 is imminent

Posted by rjlfsimons | Report as abusive

You should include charts reflecting the amount of currency in circulation, the Ms, for Europe and US. The money supply in the US has increased significantly reducing the value of the dollar while the Euros have not printed their money into devaluation.

Posted by niblick3 | Report as abusive

I’d also add that the value of a currency isn’t always enhanced when rates go up – the current strength of the Swiss Franc for instance when it climbed against most G20 currencies was to do with security and perceived risk (of other currencies). The interest rates are amazingly low for such a high value, and the press and corporates were complaining about if for ages before the SNB stepped in.

You are right to look at the strength of the underlying economy of a currency area, be it single country or zone, specifically whether that country or zone is a net importer or exporter. Net importers generally lose currency value over time, net exporters generally gain value over time, all else being stable.

Posted by FifthDecade | Report as abusive
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