Posts Tagged ‘Europe’

The stronger dollar

Friday, May 21st, 2010

My last post was titled “the strong dollar”, and there is no better title than “the stronger dollar” for this post. As the dollar has kept on getting stronger in the past few weeks.

After many years watching markets, the only fundamental truth that summarizes how markets move goes as follows: currencies are mean reverting and the extraneous shocks necessary to bring values closer to parity will occur. In other words when a currency is too pricey like the euro used to be, something will happen to make it cheaper like the current Hellenistic crisis.

And what is the best way to assess if a currency is too pricey beyond all sophisticated models created by erudite Doctors in Economics. Simply ask tourists who visit Europe from the USA or vice versa, and they will tell you when the God of Currencies has lost its mind, like when he had the euro at or over 1.50 to the dollar for a long period of time. This was so absurd that Paris was determined to be the most expensive city in the world for the cost of living according to a prominent European magazine.

Yes Paris was ahead of New York, Tokyo or Hong Kong. And given the relative wealth available in the 4 cities in question, this was simply a ludicrous bogus statistic stemming from an exaggerated value of the euro. Now back to a 1.25 FX rate, I bet you Paris is not number one anymore.

So often the highly complex econometric models from Ivy League educated Professors of Economics will equate with what all the talkative taxi drivers of the big cities in the world know from talking to travelers. Assuming such models are correct.

If there is a positive consequence from the Greek debacle, it is to bring the value of European assets back to more a reasonable level, starting with its currency the euro. The purchasing-power parity is what rules currencies at the end of the day and this is getting truer if economic players are given the opportunity to arbitrage geographical locations.

One such PPA model by the OECD said 6 months ago that the euro was 21% overvalued. Nice evaluation and it is now approximately correctly valued versus the green back. Another similar model by the IMF says that the Chinese Yuan is 75% undervalued and we all know this one. This is the reason why China is getting so strong with its cheap exports. And the Greek crisis is given them a new reason not to let their currency appreciate at this point.

USA: 0; Europe: -1; China: +1.