Saturday, May 10, 2008

What About the Euro?

What the dollar can fetch against the euro has been all over the news lately, indeed because it matters greatly. It matters if you eat euros, drive to work in euros, pay for your child’s college tuition in euros, are planning to travel to Europe, or you buy European goods.

As for European travel, I’m afraid that is a luxury good; sorry, but you can’t be taken seriously. How about a trip to the Grand Canyon instead? San Francisco is kind of like a European city in a more beautiful natural setting than most, and nothing beats New York for action and excitement. As far as buying European goods, probably something similar is made right here in the U. S. A. If we don’t make it, perhaps there is underutilized manufacturing capacity that might rise to the occasion. So long as trade deficits remain imbalanced and jobs are off-shored, a weak dollar against foreign currency is a corrective force necessary to restore the domestic economy.

So how can I defend holding cash then?

The dollar is a tool for buying American goods. The value of the dollar is measured by how well it accomplishes that task; its exchange against foreign currencies is incidental. If prices of goods in American were to drop (like say because they are overpriced) then the value of the dollar rises. So even if it is doing poorly against world currencies—even if it drops against world currencies—its value could still rise.

Since commodities, like oil, wood, and corn, are under foreign as well as domestic demand, these do become more expensive if dollar exchange rates fall; but domestically-produced commodities will yield higher profits for the national economy. So a weak dollar has a mixed but probably mostly beneficial effect if we suffer a high trade deficit.

Another way to look at it is, say to stave of deflation, the Fed inflates the dollar by a multiple of 8—and a few months later, facing the same problem, the European Central Bank hyperinflates the Euro by a multiple of 12. Does that mean the dollar is a good investment because it will rise against the Euro? Both would be horrible stores of wealth, the dollar a little less so, but horrible still. In the upcoming deflationary event; both dollars and euros are good investments, the dollar I think is slightly better since it is probably undervalued at this time.

I think the dollar will correct against foreign currencies eventually, but slowly, so the dollar would be a long-term investment if you are not planning to spend it here. Domestically, asset prices will fall from the upcoming contraction of credit, strengthening the value of the dollar as a purchasing tool.

The value of cash will rise in all countries that have a credit bubble about to pop—which means every country with a central bank, except for Japan where this has already happened. America is next on deck. Europe is a few months behind.

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