Some Fundamental Beliefs
September 16, 2015
It’s been 49 years since I first studied economics and 40 years since I worked as an analysts in the Foreign Department of the New York Federal Reserve Bank. Here’s a list — alas incomplete – of core beliefs acquired as a currency market watcher.
Currency movements are often very counter-intuitive, and a single ill-advised presumption can create a domino effect of forecasting mistakes.
Currency market history repeats but seldom in a precise way. Expect mutations.
One is taught that price equilibrium is a point that clears the market between what is demanded and the quantity that will be supplied. But equilibrium in foreign exchange tends to manifest itself as a price direction that shifts only when a threshold is exceeded of changed underlying fundamentals determining the demand and supply for a currency.
Not all developments of new technology are equally beneficial. The development of the internet and mobile revolution has not lent the same boost to labor productivity as did the introduction of the personal computer.
The exponential growth of world population in the 20th century, which broke a much shallower growth rate previously, is the prime cause of current strains on the environment that imperil the planet.
As theories, supply-side economics and monetarism provide foundations that lead to bad economic forecasting.
Trust but verify. Theory is all well and good, but the truth can only be revealed from measurement and empirical examination.
Economics is full of myths. The assumption that monetary tightening invariably strengthens a currency is false. The impact depends on circumstances.
Don’t confuse being a reserve currency with propensity to appreciate against other monies. If one thinks of appreciation versus depreciation like ball control in American football, the dollar since 1971 has spent much more time on defense than offense, yet the dollar’s hegemony among reserve currencies remains hardly challenged. And over the long term since 1971, the U.S. currency has on net fallen extensively against other widely traded hard currencies.
The link between relative growth and the strength of a currency is very contextual.
The U.S. economy has performed substantially better under Democratic presidents than Republicans from the standpoint of growth in real GDP and jobs, keeping inflation down, and promoting rising equity markets.
Current account positions matter much more as a currency determinant than generally appreciated by market participants.
During my career, inflation has become a much more global phenomenon. Assigning monetary policy exclusively to the preservation of price stability and basing monetary policy on domestic economic information will be an increasingly ill-advised approach.
Equities don’t always pay off big in the long run. From May 1947 to December 1961, the DJIA rose 10.9% per annum, but from December 1961 through mid-August 1982, the rate of share price growth was just 0.3% per year. From August 1982’s low to the high in mid-January 2000, the DJIA climbed 16.9% per year, but since that high, the per annum growth has been just 2.3%. All those periods constitute long runs. Timing is everything even when considering the “long run.”
Oftentimes, the market reaction to an event or piece of economic data provides much more insightful information than the news itself. The Conservative Helmut Kohl led the CDU/CSU to power in Germany in an election early in 1983. The dollar had been looking pricy and underwent a correction in November 1982 – January 1983. U.S. interest rates fell sharply in the second half of 1982, while the U.S. entered a second year of recessionn. Surely, so it seemed, Kohl’s win would provide additional support to the mark. Instead, the dollar embarked on a new upleg. In time, it became apparent that economic recovery had at last begun in the United States, but the earliest realization that dollar dynamics were different than thought came from the deviation of dollar/mark from conventional wisdom right after the German election.
Copyright 2015, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
Tags: foreign exchange