One-Year Anniversaries for Oil and the Euro and A Little History

July 14, 2009

West Texas Intermediate futures peaked on July 11, 2008 at $147.27 and are presently trading off 59.0% from that peak.  Gold, by comparison, dropped only about 5% on balance over that period.  Oil prices recorded lower period averages for eight consecutive months — $134.08 in June 2008, $133.97 in July, $116.69 in August, $103.57 in September, $76.81 in October, $57.27 in November, $42.32 in December, $42.06 in January and $39.18 in February — but then rose to mean readings of $48.07 in March, $50.05 in April, $59.29 in May and $69.70 in June.  Since other measures of expected and actual inflation remain subdued, gold’s resilience may reflect a hedge against international monetary reforms.

It’s not happenstance that the euro’s peak of $1.6038 occurred just four days after oil crested.  The dollar is trading 15.0% higher now than on July 14, 2008.  However, EUR/USD has been remarkably steady around $1.40 for nearly three months now.  There have been only two trading sessions since May 21st in which that key relationship failed to trade within a single cent of that pivot, a condition also met on the first three trading days of January.  The $1.40 per euro level has deeper historical roots than generally realized.  On the final trading day of 1998 when fixed parities were sealed between the euro and the founding individual currencies of the European Monetary Union, the new currency was equated to 1.95583 German marks.  The mark had been Continental Europe’s previous hegemon currency, and the German Bundesbank strongly influenced domestic monetary policy in much of the rest of Western Europe, much as Euro interest rate changes now tend to be mimicked by Denmark’s central bank.  The square root of the mark’s euro parity is 1.3985.  At $1.3985 per euro and only at that level does the synthetic mark have an identical quote of 1.3985 per dollar.  To put that level in historical context, the strongest D-mark quote against the dollar prior to the euro’s launch at the beginning of 1999 was DEM 1.3450 on March 8, 1995.  At the Euro’s peak a year ago, the synthetic mark equaled 1.2195 per dollar.  The mark traded around 4.0 per dollar in the latter 1960’s, near 3.19 per dollar after a first dollar devaluation in December 1971, and at DEM 2.90 after a second dollar devaluation in February 1973.  Flexible exchange rates replaced fixed dollar rates one month later in March 19, 1973.  $1.3985 per euro represents marginally more than a halving of the dollar’s Deutsche mark value since the pair started to float, a net 2.0% per annum pace of dollar depreciation sustained over slightly more than 36 years

One of the great ironies of the present international monetary system, an arrangement that revolves around the disproportionate importance of the dollar, wherein dollars are held as international reserves to a far greater extent than America’s share of world trade or globlal GDP, is the U.S. currency’s failure to meet an important requirement for such a role, namely a documented track record of stability as a long-term store of value.  Against its major rival, the dollar has lost 51% of its value since 1973 and 65% compared to Bretton Woods post-war parities.  Beijing officials are not the first big holders of dollar-denominated assets to question the status quo and call for modifications. Until a significant mass investor exodus from the dollar develops, it will be very hard for that process to gain traction strictly by policy design directed by political leaders.  President Obama preaches change on a wide range of policies, but here is one suggestion against which U.S. officials will offer ferocious resistance.

The dollar has advanced sharply on balance over the past year against commodity-sensitive currencies like the Australian dollar (23.5%), New Zealand kiwi (+20.4%) and Canadian dollar (13.3%).  It rose 22.5% against sterling but just 6.8% against the Swiss franc.  On a weaker note, the greenback has lost 12.4% of its value against the Japanese yen.  Although it remains 16.5% above its record low of 79.85 hit on April 19, 1995, it is 74% weaker than its yen parity of 360 in the 1960’s, an average loss of roughly 3.4% per annum over the past 39 years.

In the year since the euro and oil crested, the Dow, Dax, Nikkei and British Footsie have dropped 20-something percent.  Ten-year British Gilt and German bund yields, down 117 basis points and 107 bps respectively, declined more sharply on balance than U.S. Treasury yields or Japanese JGBs, which fell by 43 bps and 25 basis points.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.

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