The Dollar vs. the Euro?

I was talking with a friend last night and she had mentioned that she was told that the dollar is going to merge with the Euro. I wanted to laugh, as I have not heard anything like that previously, as well as the fact that the dollar is still much too entrenched into the global economy and the primary peg for global valuation. But, perhaps she knew something I didn't.

There are numerous currencies that do peg themselves to the Euro, such as the Denmark DKR, and others. If you were to compare supermarket prices in Denmark and in the USA, and remove sales taxes and VAT, the real value of the dollar in a supermarket is about 56-60 eurocents. Today the exchange rate is about 68 eurocents to a dollar. If you look at IKEA which is both in Europe and the USA and make the same comparison, IKEA values 1 dollar to 52 eurocents. I think the dollar is going through a “controlled” gradual devaluation.

Without going into any conspiracy theories and such, this current global economic condition we are seeing could be construed as a very controlled means of a trade re-balance. There are numerous countries in the far east that are invested heavily in dollars, though we find their exports and labor force increasing in strength, which is a good thing for them, although this puts a load on the dollar. In order to bring this back to the "new normal" there must be an imbalance for the market to restructure itself. Whether this is created or the natural process of our time, eventually the global trade markets will find themselves in synch again. However, in the mean time we will be going through this re-balance of economy.

Another point would be the FED and the ECB (European Central Bank) both have a common interest in the project. The FED can in that way lose a good deal of the American foreign debt, and the ECB can assist the Euro to be a new international reserve valuator. At the same time, the EU has only a small part of the dollar reserves, so their losses will be relatively small. That’s why the ECB keeps up the rates, while the FED lowers their rates.

The United States must make note, that the USA is not the largest economy in the world. In 2006 the US GDP was 13.000 billion USD, and the GDP in the EU15 11.400 billion €. With today's exchange rate that is 16.764 billion USD, or about 29% larger than the US GDP. Maybe that’s the reason for the shift in reserve valuation.

With a foreign debt of 60% of GDP and large internal public and private debt and a negative private saving rate (-2% in 2006) the US economy is in a relatively bad shape, and on top of that is the crude oil prices and the sub-prime crisis. So it is not likely, that the dollar will re-valuate in the short run.

In the long term the dollar will fall relative to certain currencies. China and India are growing in economic stature, by as much as 9%-10% growth rates, and as a result will probably have a stronger currency on a relative basis. As the oil prices increase, perhaps mainly due to the new crude appetite of these emerging economies, the U.S. should step back and begin to realize that it may not have any relation to them whatsoever. Or at least somewhat...As the Middle Eastern oil families see their massive investments and economic projections in the United States lose value, as the dollar slides they simply offset their balance sheet by raising their rates. That is simple economics and has nothing to do with war or religion. As they raise their rates they also are enjoying their new far east customers. Between the oil conglomerates of Russia and the Middle East these emerging economies will soon become their largest consumer. It is estimated by some that China will outpace the U.S. in oil imports by this next years end.

Then, without trying to confuse the issue, you have to keep in mind of how things like the trade deficit are measured. It measures dollars per sale rather than profits. For an example, Apple will bring in more of a profit line item for an iPod, or iPhone than the overseas manufacturers of all of its components. They will then put those profits in R&D (which is normally marked as consumption in stats), which in turn then again yields more profits over time.

While it is no secret that the Euro has been the disproportionate beneficiary of the global over valuation of the dollar. The same cannot be said of the Asian currencies who continue largely to peg their currencies to ours. There is also the other issue of the Middle East region who peg their oil futures to the dollar. We will get into that on another day as this is a bigger issue for our time than the Euro spread.

The question is how and where the inevitable inflation that we are creating through our accumulation of massive internal and foreign debt will play out. Devaluation is always in the interest of foreign debtor nations. "Our currency, your problem," as Nixon once said. But, with that said and in order to complete the economic cycle, will the wave of inflation also be exported? It does seems to be happening in China already. There is certainly a housing and mortgage situation happening in the Euro countries as well.

The housing appreciation bubbles in Ireland, France, and England in the past five years, as an example, have shown more of a dramatic increase in housing prices that those that the United States has encountered. We are now seeing a very dramatic slowdown in their Real Estate markets as well. With the Northern Rock fiasco their lending scene has hit the skids and pulled back. The PTI (Principle, Taxes and Insurance) ratio to income in many European areas is much more drastic than the U.S. creating a home affordability gap in some of the Euro markets to be much more pronounced. The unemployment in some of those same areas is measureably higher than the U.S. as well.

While the U.S. has debt, and too much in my opinion, there are many others countries with far more relative to their GDP. In the U.S. there is approx. $54 trillion in household wealth (stock holdings, home equity etc...), which, all in all, makes the overall U.S. balance sheet look pretty good. Although, we do need to teach our consumers how to save and invest rather than acquire credit card debt.

As we add into the mix the lowering of interest rates, which drag on the dollar too. I'm certainly not going to say the dollar is "undervalued", but I do not see the fall in value as a sign of the end of the dollar either.