Euro and Value


A weaker US dollar could reduce our standard of living.  As the greenback falters, prices for imported goods  and essentials like energy rise.

The Euro is likely to rise over coming days as there have been four elections in Europe where centerist politicians who strongly support the EU have easily won their elections.   First national elections in Austria, the Netherlands and France supported the EU.  Now Angela Merkel’s party has won an important German state election in the rival’s heartland.  All these election results support the EU and euro.

There are numerous other strong indicators that the US dollar is overvalued.

The Economist Big Mac Index is one example.  The index compares the cost of the Big Mac at McDonald’s outlets in different countries by converting local prices into dollars using market exchange rates (as of January 6th).  The idea is that long term, parities will adjust so that a Big Mac costs the same everywhere.  If a Big Mac looks like a bargain in one currency, that currency could be undervalued.

The Economist recently wrote (1):  Americans hunting for cut-price burgers abroad are spoilt for choice: the index shows most currencies to be cheap relative to the greenback. This is partly owing to the Federal Reserve’s decision to raise interest rates when the central banks of the euro zone and Japan are loosening monetary policy. The euro is 19% undervalued against the dollar, according to the index, and the yen 37%.

Here is the FT’s chart showing the

FT

We can also see euro (versus dollar) strength by looking at the Trade, exchange rates, budget balances and interest rates section of the Economist (2).

FT

Trade balances and Current-account balances are major factors unpinning currency strength.   Currently the euro area has a $398 billion current account surplus which represents 3.1% of GDP.  The US has a $481 deficit (-2.7% of GDP).    That’s nearly a trillion dollar gap in Current-account balances between the euro area and US.  This exerts a huge downwards pressure on the greenback.

Budget balances also impact currency strength and once again the euro area has a far stronger position with a 1.5% of GDP deficit versus the US deficit of 3.5%.

Finally, and perhaps the most important factor in currency strength, is its interest rate.

The US dollar interest rate is currently eight times higher than the euro.   The euro interest can double, triple or even quadruple and still be way below the US dollar’s rate.   Such a rise would create an upwards pressure on the euro versus the dollar.

Since the US administration wants a weaker US dollar, it is doubtful that the US would raise rates to protect dollar strength.  This is especially true since the US debt is at an astounding 20 trillion dollars and only serviceable with low interest rates.  A rising US dollar interest rate will be a disaster  for the US budget.

All these factors bode well for the Good Value Keppler Developed Market Pifolio we track in the Purposeful investing Course as six of the 10 good value markets are denominated in euro.

Inflation has been slow for many years, but started to heat up in the second half of 2016 as gasoline prices rebounded from a steep downturn. The consumer-price index increased 2.2% in April 2017 from a year earlier.

Wages have been rising a little better than 2% annual raises, on average, for the past three years so when factoring in inflation, the pace of pay increases, even with a strong US dollar, are near zero or losing purchasing power.

As the dollar declines, those on fixed income should expect their dollars to buy even less.

One way to protect against this loss is with good value non-dollar investments such as those described below.

Gary

(1)  www.economist.com/news/economic-and-financial-indicators/21721684-trade-exchange-rates-budget-balances-and-interest-rates

(2)  www.economist.com/news/finance-and-economics/21685489-big-currency-devaluations-are-not-boosting-exports-much-they-used-after


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