Maybe it’s because a lot of them are wrong. (1 Euro was worth about 1.22 US dollars when I made this prediction and is worth about 1.27 dollars now.)
It’s a truism that market trends often continue beyond our expectations. This is especially true in currency and interest-rate markets, because these are dominated by governments that have the resources to make markets go where they want them to — at least for a while. The Euro is backed by nothing more than political expectations about the behavior of the European Central Bank; the Euro’s current historically high valuation vs. the dollar is largely a function of the Bush administration’s economic ineptitude and politically-driven dollar bashing. These factors are subject to change and sooner or later the Euro will lose value against the dollar. I don’t know when this will happen or how high it will go first.
UPDATE: Paul Johnson makes a strong case for the Euro’s coming downfall, and argues that the U.S. should cultivate relationships with European countries that share its interests:
I’ve always maintained that the moment France finds theEU to be no longer of use, it will break it up. A German revolt against the payments system could provide that moment. Hostility to the EU is rising in France anyway, to the point where no referendum on the proposed EU constitution can be held there for fear it would be voted down heavily.
U.S. policymakers’ aims should be to forge close links with in-dividual countries that have strong common interests with America in wide areas of policy. Such nations include Britain, obviously (though not Ireland, which is sure to do the opposite of anything Britain does), Spain and Italy. The latter two are deeply resentful of French-German behavior and are anxious to have a powerful friend outside the EU to redress the internal balance of power.
Johnson’s argument isn’t new, but it appears that events may at last be catching up to it.
George Stigler, one of our portraits above, was once asked about the stock market. He said, if I could accurately predict anything about the stock market, I’d be talking to you from behind my solid gold desk. Exactly.
You point out a major element of politically-driven markets: the actors themselves often do not know what they are doing, or don’t even know what they are trying to do, or why. Policy incoherence makes prediction even more impossible.
The thing with predictions is not so much whether you were wrong or not. Rather, they are tests of your assumptions about the world — economic, political, military, whatever. You can be wrong, but then see that information you could not have possessed was critical, for example. That would not mean your basic understanding, your basic “model of reality”, was wrong. If however, you are consistently wrong and do not have plausible reasons for being wrong, then you have to reassess your basic understanding.
The one thing I have found helps me accurately understand what is going on in the world and more or less accurately predict what is going to happen is reading lots of history — again, economic, political and military. I will put up a post revisiting my 2003 predictions at some point. I did OK, actually.
Of course, if you are a currency trader, your “predictive” power is also your income stream. Fortunately I am in an easier line of work.
Whoa.
I don’t think US policy is incoherent. They know what they are trying to do and are doing it effectively, but it’s the wrong thing to do. Everybody knows that, there is no confusion, and therefore, absent changes in ECB policy, the dollar is likely to remain weak vs. the Euro as long as the Bush administration continues with its current policies.
I think the whole point is whether I am wrong or not. That’s what makes predictions useful. If you dilute the significance of the mistakes you are also diluting the significance of the correct predictions. Also, the more variables you use in your predictions, the more likely you are to misinterpret the results. Assumptions are one way to avoid drawing incorrect conclusions, but I would rather user fewer variables and make fewer assumptions.
Whoa yourself.
This dollar policy horse has been getting a brutal beating. We’re taking in over $100 billion per day in foreign investment. Treasury has NO problem selling our debt despite our paying a pittance in interest. We may actually start rolling this low-interest debt further up the curve, which would be a fiscally prudent move. At the same time, these foreign investors are hedging their currency risk, driving down the dollar. You would think that a steadily weakening dollar would be relentlessly pressuring our capital markets, but that is not happening, and this dollar slide has all evidence of being extremely orderly. Treasury has obviously expended (wasted) no ammo defending the dollar, leaving all mechanisms in a stronger position to address any crisis were it to develop. On the other hand, if you want to see this nascent domestic as well as global economic recovery catch a bullet between the eyes, you could throw all policy tools in the bag at strengthening the dollar right now. Like it or not, the U.S. is the world’s engine, now and for the foreseeable future, and the weakened dollar is only helping that engine to pull the rest of the sordid, corrupt, broken down train up the hill.
Whoa.
Whoa is me.
At the present moment, the Russian people are continuing in a decentralized fashion to convert their economy from dollar-based to euro-based, but IMHO they will switch back when the dollar continually becomes stronger.
I’ll play the fool for a while: What if the dollar is actually currently strong against the Euro? I have no basis for this assertion, but I have yet to hear a good argument against it not based on historical relative prices.
Either the dollar’s continuing weakening represents expected political economic fundamentals or it represents currency trader foolishness.
All apologies if needed to Jonathan, I didn’t mean for my diatribe to be too harsh! That’s an interesting take Kevin, allow me to throw out a couple others. Since the Euro launched, we have essentially had three years of losing value followed by two years of regaining value and surpassing it’s birth level. I say that was the markets saying “I spit on your New Currency, ptooey!” followed by profit taking, short covering, and the realization that The Euro was not going to be wallpaper. Now the pendulum has swung the other way, markets overshoot reasonable levels all the time. Add to that the fact that we as a nation had become fairly uncompetitive versus the rest of the world on many fronts, and this move looks like a much needed correction.
The economy is not rebounding because of the weak dollar (which helps exporters but hurts importers and and raises prices for imported goods). It is rebounding because business has digested most of the failures of the recession and become more efficient, because of the tax cuts (a good idea) and because the Fed pumped up the money supply. They overdid the money and now gold is $420/oz and govt bonds are a lot cheaper than they were before last summer. And the Fed has so far declined to raise short rates, and won’t admit that it may have miscalculated. It’s no surprise that the dollar has been weakening.
Some of the weakening was reasonable, because the dollar at 1.20 EU/USD was probably overdone. The problem is that the Bush administration has been talking the dollar down further, and trying to get trading partners like China to revalue their currencies, and engaging in protectionism. These measures are hallmarks of weakness and undermine confidence in the Administration, in the dollar, which has continued to slide, and in U.S. investments generally.
Bush’s people have done little to indicate that they want a stable dollar. Their leaks and policy announcements have generally been framed either to express satisfaction with the current situation (i.e., dollar weakness does not trouble them) or to increase uncertainty about our policy. Both of these reactions further weaken the dollar.
The absolute level of the dollar isn’t as important as stability. For several years the Fed, in an overzealous attempt to forestall inflation, held back money creation and kept short rates high. The dollar deflated and became overvalued vs. the Euro and gold. This deflation may have helped to kill the bull market in 2000 and bring on the recession from which we are now emerging. More recently the Fed appears to have overdone it in the opposite direction — in an ongoing attempt to fight deflation, they have printed too much money, kept short rates too low, and driven the dollar down and gold up. Maybe productivity and economic growth will be strong enough to absorb the extra liquidity and everything will work out OK — i.e., the current inflation fears, dollar realignment and pop in gold prices will be the worst that we experience. In that case, fine. But the markets suggest that we are flirting with increased inflation, and I think it’s unwise to run that risk casually.
The Bush administration, in politicking the dollar for union and exporter votes, is creating uncertainty that exacerbates the problem. This is reckless and they shouldn’t do it. The first rule for policy makers in such situations should be to avoid increasing uncertainty.
As for my prediction that the Euro will lose value, I could be wrong about that too. OTOH, the Euro is backed by air, so what happens to it when the U.S. finally gets its monetary act together?
Andy: No apology is necessary. I just hope we didn’t scare Lex away.
Kevin: Interesting point. I would still bet on the dollar in the long run, however. While the dollar is a fiat currency like the Euro, the ECB faces many unresolved (and I think unresolvable) political tensions that I think will eventually express themselves in monetary policy.
“…the Bush administration’s economic ineptitude and politically-driven dollar bashing…” Jonathan said this. These things, being about politics and policy and not fundamentals, can change without notice. Unlike, say, the total amount of copper which can be extracted worldwide in the next quarter, which has some known upper limit. Hence the difficulty of making predictions where political factors dominate — they can fluctuate at the whim of decision-makers. So, I’ll stick with my comment.
“I think the whole point is whether I am wrong or not. That’s what makes predictions useful.” I wasn’t talking about predictions which are useful, so we are talking past each other. I qualified my comment, noting that currency traders, for example, rely on their predictions for their income. I don’t. Any “predictions” I make are the equivalent of “paper trades”, hence not “useful”, other than the utils I suppose I subjectively derive from engaging in conversations about all this stuff. I occasionally make nominal bets on elections, but that’s it. If I were a trader, I’d have to be more serious about predictions, but I’m not, so I’m not. Practicing law requires few “predictions”, in my observation.
On the substance of all this, I suspect that Bush is being much like Nixon, going out and over the edge, taking economic risks to secure his reelection, figuring that by the time the piper has to be paid, he’ll have four years to work on it. In other words, even if Jonathan’s concerns are all merited, Bush & Co. have discounted them against the near-term political benefit of their policies. Of course, they could be wrong. But, if you are standing att the table, you have to play, and whatever policy mix you chose, someone’s bound not to like it. Bush is hoping that important swing constituencies in close states do like where we are and what he is doing. That’s the game.
As to where the Euro really ought to be compared to the dollar, I don’t have the faintest glimmering of an idea.
Jonathan,
Although you aren’t paid for your opinion, there are a hell of a lot of morons out there who are not fit to carry your jock when it comes to understanding econ and markets, making healthy incomes from proffering their opinions on markets. I deal with their former subscribers every day. Ironic, eh?
Gentlemen,
Does anyone in this Chicago crowd also feel that the problem almost exclusively lies with the Fed introducing more money into the economy? In fact, by default, isn’t every additional dollar doled out by the Fed devaluing all the dollars in our collective pockets?
Lately I have been wondering why any additional dollars get printed at all. The Fed needs them to dole out to ailing banks, hoping sticky prices will help an inflationary fiat currency to rescue a bank sufferring from a bank run. But why should such a bank need rescuing at all, when it has given out these many bad loans? Should it not, like any other business, have an insurance policy instead? Why should the Fed be rescuing bankers by taxing the rest of us? (Inflation is, after all, the ultimate hidden tax).
The Fed has pumped in approx $1.3 trillion into the world economy during 2003. Isn’t that a little messed up? It would seem to me that the current boom is merely inflation-induced malinvestment driven. The inflation is already showing itself in the US housing market and probably the stock market. CPI/PPI are lagging indicators that don’t really mean anything – how else can we measure inflation but by measuring growth in the money supply?
Indeed… after 4 years of a Chicago (well, actually Chicago-inspired Rochester) economics education, I am wondering why at all money supply should ever be increased by any government.
Any thoughts?
– Rahul
I agree with many of the comments. I also like currency trading a bit, and it makes it way more interesting when discussing the world economy when u got even more riding on the outcome… so I’ll re-iterate my most important points that I am trading on.
“The Bush administration, in politicking the dollar for union and exporter votes, is creating uncertainty that exacerbates the problem.” And yes it is reckless, as is putting tarrifs on steel, bra’s the subsidy of agriculture.
But the common man will not throw bush out for having a big deficit, or the euro/dollar price… He will throw Bush out if he feels he isn’t defending US jobs. Hence I’m guessing will have the Euro at least at 1.4 in a years time….
I just read that combined Asia (mostly China and Japan) own over 50% of our Treasury Bonds. For now they are happy to do this as long as it props up thier currency(YEN/USD has only decreased by 10% while EUR/USD by 21%).
So the question is what will force either the US or the rest of the world to change policy? When Japan is tired of hold our debt, which is depreciating, and doesn’t give them much interest anyway? Don’t see this happening unless a roaring economy in China allows them to care less, and I think China’s economy is much more likely to weaken. When is China forced to inflate its currency. hmm, not sure on this one.
When and how do we get rid of our trade deficit? Warren Bufffet wrote what I thought was a great piece in Fortune. I believe that we cannot buy more than we sell in the longer term…. and the trend line doesn’t look so great. I do think that it will take us depreciating the dollar a hell of alot more than we have currently. Hence, maybe the dollar is still strong even from a fundamental perspective??
Has anyone seen any good responses to the buffet article?