How bad is the condition of the euro? That’s the question on my mind today. One way to look at the euro is by comparing it to the dollar. The past three months seem to suggest volatility.:
(Click on image to enlarge)
But this seems completely counterintuitive to the news lately. The euro has even stolen the headlines from the end of QE2. Every day, it seems to be one thing or another about Greece. The news trend is clearly downhill for the euro, not a mix of good and bad. In my opinion, the dollar is adding a lot noise to this chart, since the USD is not doing so hot either. As a result, alongside the dollar, the euro only appears to be volatile.
Maybe gold can give us a better picture of the euro’s condition. After all, with fiat currencies headed down, gold should be on the way up.
(Click on image to enlarge)
Here,the picture comes closer into focus. Clearly, gold is pushing an upward trend, but the last few months seem less clear. At first, gold fell; and now it’s jumping back with renewed vigor. Nonetheless, more factors affect gold than just the value of the euro. Hence, we can’t attribute this whole move to the euro alone.
However, one chart tells the story best: the Swiss franc-to-euro chart. This currency pair doesn’t often make the front-page headlines, but in this case, it’s very important.
(Click on image to enlarge)
There’s no doubt about it. This is a straight shot down. Think about the significance of this: Switzerland is tied at the hip to the eurozone. If Europe’s economy goes downhill, Switzerland will also feel the pain. Hence, we can’t attribute the difference to non-currency factors. For example, in the EUR/USD pair, a good manufacturing report or a decent nonfarm payroll number could create a difference between the two currencies. But bad unemployment numbers in Germany aren’t exactly a promising sign for Switzerland either.
Consider the difference in interest rates. The Swiss benchmark rate has been stuck at 0.25% ,while the eurozone’s rate has increased to 1.5%. Theory would suggest that this means a stronger euro and a weaker franc – the exact opposite of the current outcome. At first, traders explained the appreciation in the franc by predicting a rate hike soon. Well, it’s been a few months, and the rate has not followed the ECB.
Hence, with the EUR/CHF chart, we can analyze the real condition of the euro in as close to a vacuum as possible. And it doesn’t take a genius to see its direction in past three months – straight down.
Kevin Brekke is up next with a great article on Chinese inflation, trade, and what may happen with the yuan. Before we get to that, however, I’d like to announce that there’s a new Casey phyle forming in the downtown Chicago area. To learn more about that group, contact email@example.com. To learn about any phyles in your area, please email firstname.lastname@example.org.
By Kevin Brekke
Just when the dust-up surrounding fraud allegations against Sino-Forest looked to have slipped off the front page ,we got hit with another “sino” announcement last week: China released its trade numbers for June. They showed a surplus of $22.3 billion – considerably wider than anticipated – and smashed consensus estimates.
China registered a trade deficit in the first quarter of this year, the first such occurrence in seven years. The quarterly deficit yielded some temporary cover for Chinese officials against the chronic calls by U.S. officials for further yuan appreciation. However, the deficit appears to have been a one-off event as a surplus re-emerged in roaring style in April and remained positive in every month since.
Like so many of today’s governments, China is struggling to attain a balance among many competing fiscal and economic forces. Often, policies used to tackle one area will aggravate another area. In particular, the juggling act between maintaining sufficient GDP growth to ensure ample job creation while also keeping inflation in check is now looking a little shaky.
In an effort to tamp down rising prices, the People’s Bank of China (PBOC) has raised interest rates five times since mid-October and increased banks’ reserve requirements numerous times to rein in liquidity. With inflation for June reaching 6.4%, a return to trade surpluses, and an expected 9%-plus rate of GDP growth this year, fears that monetary tightening would kill growth have subsided.
China’s inflation is not across all sectors and is being driven by rising prices for food, energy, and industrial commodities. Regardless of the source of inflation, it is a serious concern for Chinese officials. Chinese history shows that periods of high inflation are associated with social, economic, and political unrest – all things that the central planners in Beijing wish to avoid.
Toward that goal, the return to stronger export performance might provide a convenient pretense for another round of yuan appreciation. A strengthening yuan would lower the import cost of commodities and energy, both essential components throughout the food chain. China is the world’s biggest consumer of energy and soybeans, and its import bills have been soaring.
So, what are the odds that the yuan will be allowed to rise?
Managed Floating Exchange Rate
First, let’s take a look at the managed exchange rate of the yuan against the dollar, as it yields a chart unlike any other currency pair:
(Click on image to enlarge)
Since October 1, 1998, the yuan had been trading at a fixed rate of 8.27 to the dollar. The only variance in this rate happened at the third decimal point (.001). On July 21, 2005, the PBOC announced a revaluation to 8.11 per US$ – a 2% rise – and the switch to a managed floating exchange rate. The yuan would begin to trade in a 0.3% band around a midpoint to be announced daily by the central bank.
By May 18, 2007, the yuan had risen to 8.11 from 7.67 – a 5.4% gain – and China widened the daily trading band to 0.5% in response to criticism about the slow pace of yuan appreciation. The yuan would rise by 11% over the following year.
On July 18, 2008, with the yuan trading at 6.82, China announced a return to the dollar peg in response to the global financial crisis, intending to protect its export market. As you can see, the central planners are very efficient at implementing and maintaining a fixed exchange rate, with the rate returning to near flat-line stability reminiscent of the pre-2005 years.
Then on June 19, 2010, China announced a return to increased flexibility in the yuan exchange rate. The yuan had its largest one-day gain, 0.42%, since China adopted its managed floating policy in 2005 and hit 6.79 per dollar. The yuan has since steadily floated higher and trades today at about 6.46, a 4.8% gain.
With the exception of the July 2008 “crisis” announcement, changes in China’s management of the currency have been preceded by calls from academics and officials within the party for the currency to rise. And recently, in reaction to rising inflation levels in China, high-profile voices are again expressing similar sentiments and backing another rise in the yuan.
Of note, an official with the State Administration of Foreign Exchange said the trading band should be expanded to 1%. Premier Wen Jiabao has said that the exchange rate may play a role in controlling prices, and deputy central bank governor Hu Xiaolian said more yuan flexibility would ease inflation pressure. Two prominent Chinese state researchers also called on the government to use the yuan to help curb inflation.
Christy Tan, a foreign-exchange strategist at BofA-Merrill Lynch, observed, “The recent comments appear to have been sequenced deliberately,” saying she thinks China is close to further currency loosening.
And if the history of the correlation between widening the trading band and yuan appreciation again holds, the currency could rise sharply in the months following any announcement on additional currency easing from the PBOC.
[Do you know about China’s secret plot against the U.S. dollar? Listen to this presentation, then take action to profit from this knowledge. A three-month trial subscription to BIG GOLD is risk-free – and your timing couldn’t be better.]
Anthony Bourdain in Cuba (YouTube)
Personally, I’m a big fan of Anthony Bourdain’s show No Reservations. On the show, Bourdain – a former NYC chef – travels the world and samples exotic foods. He doesn’t always visit just the five-star restaurants, but instead searches out local joints and the family meals of his destination. In the upcoming season, he visits Cuba.
The link above shows one of his interesting experiences there. A certain square in Havana is designated as the local place to argue over baseball. But one can’t do it without government approval. Regular people arguing over nothing more serious than baseball must be registered and licensed with the government. Can you think of anything more ridiculous?
On a side note, in his most recent book, Medium Raw, Bourdain describes himself as leaning libertarian.
UN Grudgingly Admits Wealth Creation Driving Reduction in Global Poverty (The Vancouver Sun)
Without too much fanfare, the United Nations admits in its newest report on the progress of the so-called Millennium Development Goals that wealth creation and not wealth redistribution is the main driver behind reduced levels of extreme poverty around the world.
Of course, the UN, being an organization that spends most of its time chastising rich countries for not transferring enough money to the developing world – the total last year came to $128.7 billion, the highest ever – is not quite so explicit with its admission.
A reader sent in this interesting article about the United Nations admitting that wealth creation rather than wealth redistribution solves poverty. But in the same report, the UN goes on to push for more redistribution. This sad state of affairs has been going on for a really long time. Economists have known about this, yet the aid groups keep pushing the same old ideas. If it doesn’t fit the script of “responsible First-World country sending aid to helpless nations,” they don’t really care, regardless of the facts.
How Will Economics Respond to Its Crisis? (Brad DeLong blog)
Here’s a pretty good short article from Brad DeLong (an economics professor at Berkeley) on the sad state of economics in academia post-crisis. In my opinion, DeLong is kind of a Krugman-lite. When he’s not being a shill for the left wing, he’ll make a few great comments or will defend his points with credible and rational arguments. Regarding this article, I don’t agree with him on everything, but nonetheless, it’s an interesting read. Hat tip to Lewrockwell.com for the link.
That’s it for today. Thank you for reading and subscribing to Casey Daily Dispatch.
Casey Daily Dispatch Editor