Important currency wars and volatility

Important currency wars and volatility

28 October 2019 from Mikael Syding

Important currency wars and volatility

Currency war is nothing new. It is the lazy country's solution to financial problems as a result of
poor governance and politics. "Our currency, your problem" has e.g. The US provocatively said,
when the dollar exchange rate caused problems for other economies. Sweden, Greece and Italy
have many times actively lowered the value of their national currency to make what is produced
in the country cheaper for buyers from the outside. And in the wake of the 2008 financial crisis
and the problems for many countries to gain some momentum on the economy, the (war)
central banks are competing to succeed in getting the weakest currency.

At the top of this sit the United States and China, with their protracted conflict over both trade
agreements and exchange rates. In addition, there are significant side shows in the form of the
euro's goods or non-commodities, the pound and Brexit, and not least completely alternative
currencies such as gold and Bitcoin.

Sometimes it is easy to believe that the currencies do not move so much that it matters. The
dollar index DXY, which often figures in negatively angled macro analyzes, has moved between
95 and 100 in the past year and is currently in the middle of that range. But if the "normal" level
has been at a fairly narrow range around 90 for many decades there have been exceptions. In
1985, DXY stood at 160, roughly double the level, both just five years earlier and two years
later. The question is whether a new outbreak is underway, and in which direction.

Most people seem to agree that the United States and the dollar are given safe harbors in a
crisis, which indicates that the outbreak would be going up again. Signals of dollar deficits in the
euro-dollar market also speak for it, as does the reluctance the Fed has so far shown against
following the rest of the world at negative interest rates. On the other hand, the US needs a
weak dollar to support its export industry. And how long and how much QE can be done, and
how large deficits can the budget go with year after year, before the currency falls? In the end, it
will probably still be the case that the United States is still the biggest, best and most beautiful,
which at least results in a much stronger dollar exchange rate first.

The euro is special in its own way. Over the past year, the relationship with the dollar has been
surprisingly stable, with movements of only +/- 3% around the average exchange rate of 1.12.
Here, too, one should probably see the silence as the warning itself. The longer a volcanic
eruption lasts, the worse it will be for the tensions built up in the silence. Remember that as of
February 2018, the rate was 1.25 and just before the financial crisis in 2008 it was 1.60. The
likely movement for the euro is not back to 1.60 but rather the opposite. As the dollar
strengthens and peripheral economies face problems, not least European banks, the euro crisis
will learn to flare up again and with the issues of both the monetary union and the economic
union in Europe. It will give at least as weak a euro as the dollar can become strong. The rates
look stable at the moment, but the tug-of-war between various central banks is only getting
more and more intense. The foreign exchange market may well become the epicenter of the
next financial crisis and then it is hardly the euro you want to own.

Given the ongoing Brexit tours and detours, GBP is also remarkably stable. Against the euro
area, which is where the “exit” is most relevant, the rate has gone from 1.12 to 1.18 to 1.07 and
now latest at 1.16, which is close to the highest level since the referendum in 2016. It is almost
as if the governing bodies know that it will never be anyone Brexit, or know that they will do
everything in their power to prevent it. In any case, the market has called the danger over, but
given the movements over the last 4 years, a lower pound than a higher one is more likely.

The most interesting of all currency pairs is USDCNY. This is where the real currency war takes
place. Over the past year, the rate has gone from 6.67 to 7.18 (+ 8% for the dollar) and thus
through 7.00, which is perceived as an important signal level for China's currency intentions. As
of March 2018, the rate was 6.23, so you can almost understand that Trump's patience has run
out. The question is not what the US wants, but what China wants, because it is China's
exchange rate and the US's problems. Where the United States is governed by four-year
presidential cycles, China has a much longer perspective when planning its future global

Currency wars and reserve currency status have been important for the last hundred years, but
perhaps we are nearing an end to the experiment with fiat currencies. The whole world, with the
US and China in the lead, has driven up debt faster and higher than ever in history. This has
been done with the aid of printing presses, QE and fractional reserve banking (ie commercial
banks have the right to create money against a very small capital buffer). Of course, it is still
interesting to consider exchange rate movements, GDP growth and interest rates in order to
form an idea of an appropriate asset allocation between, for example, equities and bonds, or for
some traditional fiat currencies.

However, one should not forget about Bitcoin and gold, both of which more or less slowly
increase in value relative to the paper money. Gold has held the level around USD 1500 / oz
surprisingly well after the outbreak before the summer, and Bitcoin continues to surprise
positively, although the high volatility often causes weak hands to be shaken out when the long
trend is temporarily unclear. Last week, for example, rose The Bitcoin price in dollars suddenly
increased by over 40 percent in a couple of days, with no clear cause. Then the gold price is
considerably more stable, but then you also know that there is a yellow stone at the bottom,
rather than "just" math. Nevertheless, the gold price increased by as much as 30% in dollars
from about 1200 in November 2018 to 1560 in September 2019.

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17/01/2021 14:51:26


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