Where do we start, two
weeks ago the Euro was trading at 1.19 its now at 1.15 -- not a huge move but
it's directional -- that means that the market thinks that the Euro has further
to fall against the US dollar. The question is always the same how far
will it go! More than 4 years ago I was certain that the Euro was on
one-way road to sub 1 US dollar rate -- the reason was that while the US
economy was not hitting on all cylinders it was doing OK, whereas Europe was in
real trouble. I still am convinced that the European experiment cannot
continue the way it's going, either it breaks apart or further integration
will occur.
The fate of Italy, Greece, Portugal, and Spain hang in the balance. There are no real tools for correction in Europe -- in a sense, Europe needs what all good unions require a method of creating transfer payment between the rich and poor regions. In Europe, the opposite has occurred. The Germans, who basically entered the Euro with an undervalued currency took Europe over -- the long game! While the south Europe entered with overvalued currencies, created instant wealth -- but destroyed their industrial base, moreover it allowed governments to delay institutional reforms. Only two countries took aggressive action after 2010 – when the wheels came off: Portugal and Spain and this resulted in massive social and economic dislocation. Luckily for these two countries their brightest and most entrepreneurial were able to find jobs, but often not in their own country.
The fate of Italy, Greece, Portugal, and Spain hang in the balance. There are no real tools for correction in Europe -- in a sense, Europe needs what all good unions require a method of creating transfer payment between the rich and poor regions. In Europe, the opposite has occurred. The Germans, who basically entered the Euro with an undervalued currency took Europe over -- the long game! While the south Europe entered with overvalued currencies, created instant wealth -- but destroyed their industrial base, moreover it allowed governments to delay institutional reforms. Only two countries took aggressive action after 2010 – when the wheels came off: Portugal and Spain and this resulted in massive social and economic dislocation. Luckily for these two countries their brightest and most entrepreneurial were able to find jobs, but often not in their own country.
Southern Europe is a bed
of underutilized labor, fragile economies with massive imbalances that cannot
be corrected (there is simply no mechanism).
The tragedy of Europe is that its politicians took the easy road – growing
their members rather than improving integration and balancing mechanism. This policy error should have yielded a much
weaker currency. What I had not taken into consideration is the human
element in the form of the ECB, that "bought" the market by printing
money (aka Quantitative easing). The impact was to lower the price
of risk -- since the ECB was the buyer of last resort, it flattened the
yield curve -- and made everything look good.
Therefore my F/X prediction radar is terrible -- I got the Euro wrong. I got the CAD right, but that currency is less about Canada and its conservative monetary policy than about the price of natural resources -- when king copper and oil prices rise (as they have over the past few weeks) then the CAD goes up. No magic, no great thinking -- the CAD is a great proxy for natural resources -- end of story.
The US dollar is more interesting, some would say that the recent North Korean saber rattling is all about China, maybe, I still think it’s mostly about North Korea and Trump looking for a war to boost his popularity (it worked for Bush). For now, the dollar remains the world's reserve currency two reasons its relatively safe, there are lots of dollar and dollar-denominated assets and its very liquid (less than it was a few years ago, but still). However, as of a month ago certain oil price contracts are priced in Yuan. Comentators are not appreciating the importance of this shift: Nearly 1/3 of all middle eastern oil ends up in China…
Another currency of interest is the Mexican Peso (third most traded currency after the USD and the Euro) because it beats to another drum: The Peso represents three specific aspects of the world's financial order: (1) The peso is the currency of Mexico and it is the US's third largest trading partner after China and Canada, (2) The peso is a proxy for investing in Latin America and (3) the peso is the currency of Mexico and is very very liquid.
As a pure play between Mexico and the US the NAFTA issues are getting very serious indeed. There is a “feeling” that the Americans are looking for a way to get out of NAFTA and will do this at the most convenient time -- just after the Mexican election in June 2018 -- they're not entirely stupid they don't want to make the Mexican election about Anti-America.
In summary:
(1) On the Euro -- I have no idea where that currency is going. Domestic factors in Germany are critical, but the action of the Italians are equally important, as are the current negotiations with Britain for its exit from the European Union. So good luck with having a view on the Euro!
(2) The CAD is easy -- tell me where the world economy is going -- and I will tell you where the CAD is going. Years ago, one of Canada's largest pension fund stopped investing in China, because the correlation between Canada's economic growth and the growth of China were high -- reducing the value of diversification (a topic for another day)
(3) The US dollar is almost certain to rise against a basket of international currencies -- trade war (or actual war) tend to be good at creating uncertainty, and a reserve currency always goes up during uncertainty. However, the rise of the Yuan cannot be underestimated.
(4) The Mexican Peso has only one road ahead -- devaluation, orderly over time, but it remains that Mexico's higher inflation, will by definition lead to a lower Peso...As a proxy for LatAm, and the view that the Americans will be more insular for the next 4 years (short of a war) then we can expect a weaker peso.
(5) Yen, Yuan, etc etc. The Yen used to be an important currency, but consider little international trade is conducted in that currency -- most sovereign debt is held by the country -- in general, there is little appetite. As for the Yuan, the situation is far more interesting. Right now, there are serious currency control on the Yuan -- until these go away, there is little scope for the currency to trade more aggressively. But now you can price oil in Yan, and the country is one of the largest importer of oil…especially from the Middle East. The impact there can be massive. Only time will tell.
Overall, we live in interesting times -- which it turns out is a Chinese curse!
Therefore my F/X prediction radar is terrible -- I got the Euro wrong. I got the CAD right, but that currency is less about Canada and its conservative monetary policy than about the price of natural resources -- when king copper and oil prices rise (as they have over the past few weeks) then the CAD goes up. No magic, no great thinking -- the CAD is a great proxy for natural resources -- end of story.
The US dollar is more interesting, some would say that the recent North Korean saber rattling is all about China, maybe, I still think it’s mostly about North Korea and Trump looking for a war to boost his popularity (it worked for Bush). For now, the dollar remains the world's reserve currency two reasons its relatively safe, there are lots of dollar and dollar-denominated assets and its very liquid (less than it was a few years ago, but still). However, as of a month ago certain oil price contracts are priced in Yuan. Comentators are not appreciating the importance of this shift: Nearly 1/3 of all middle eastern oil ends up in China…
Another currency of interest is the Mexican Peso (third most traded currency after the USD and the Euro) because it beats to another drum: The Peso represents three specific aspects of the world's financial order: (1) The peso is the currency of Mexico and it is the US's third largest trading partner after China and Canada, (2) The peso is a proxy for investing in Latin America and (3) the peso is the currency of Mexico and is very very liquid.
As a pure play between Mexico and the US the NAFTA issues are getting very serious indeed. There is a “feeling” that the Americans are looking for a way to get out of NAFTA and will do this at the most convenient time -- just after the Mexican election in June 2018 -- they're not entirely stupid they don't want to make the Mexican election about Anti-America.
In summary:
(1) On the Euro -- I have no idea where that currency is going. Domestic factors in Germany are critical, but the action of the Italians are equally important, as are the current negotiations with Britain for its exit from the European Union. So good luck with having a view on the Euro!
(2) The CAD is easy -- tell me where the world economy is going -- and I will tell you where the CAD is going. Years ago, one of Canada's largest pension fund stopped investing in China, because the correlation between Canada's economic growth and the growth of China were high -- reducing the value of diversification (a topic for another day)
(3) The US dollar is almost certain to rise against a basket of international currencies -- trade war (or actual war) tend to be good at creating uncertainty, and a reserve currency always goes up during uncertainty. However, the rise of the Yuan cannot be underestimated.
(4) The Mexican Peso has only one road ahead -- devaluation, orderly over time, but it remains that Mexico's higher inflation, will by definition lead to a lower Peso...As a proxy for LatAm, and the view that the Americans will be more insular for the next 4 years (short of a war) then we can expect a weaker peso.
(5) Yen, Yuan, etc etc. The Yen used to be an important currency, but consider little international trade is conducted in that currency -- most sovereign debt is held by the country -- in general, there is little appetite. As for the Yuan, the situation is far more interesting. Right now, there are serious currency control on the Yuan -- until these go away, there is little scope for the currency to trade more aggressively. But now you can price oil in Yan, and the country is one of the largest importer of oil…especially from the Middle East. The impact there can be massive. Only time will tell.
Overall, we live in interesting times -- which it turns out is a Chinese curse!
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