Sunday, 22 January 2012 00:00
There is little question that the end of the Bretton Woods system of fixed currency rates in the 1970s led to major changes in the global financial markets. Forex trading has become an enormous global market and it is hard to listen to an hour of financial news TV without hearing some mention of what's going on with the dollar.
Although fixed rates meant that for much of financial history the topic of forex rates was rather dry and academic, things have certainly changed since then. There has been a remarkable increase in trading volume and volatility and many major currencies have seen major swings in the floating market since 1990.
The British Pound
Once the most important currency in the world, the British pound ultimately gave way to the U.S. dollar, but is still significant in terms of currency trading volume. Curiously, the British pound spend the last 21 years moving all across the board only to end up more or less where it started; a dollar bought about 61 pence on Jan. 1, 1990, and buys about 65 pence as of January, 2012.
The depths of the housing crash and credit crisis were definitely bleak when it came to the U.S. and the strength of the dollar, as the global markets widely and correctly assumed that the U.S. would pursue an easy-money policy to work through the wreckage. At the worst, the U.S. dollar bought only about 48 pence.
Those doldrums did not last all that long, though, and the dollar rallied sharply in late 2008, likely due in no small part to the European sovereign debt crisis and the realization that for however bad the U.S. economic and monetary situation was, the European situation was likely worse. The U.K. had to worry not only about its trading partners and the health of the City, but also its own banks. The dollar peaked at over 70 pence in March of 2009, not the all-time high over the past 20 years, but within a penny of it.
No discussion of the modern pound's trading history is complete without mentioning Black Wednesday. The European exchange rate mechanism (ERM) was first introduced early in 1979 as part of a long-term plan that ultimately became the euro, but the U.K. did not join until October of 1990.
Unfortunately, the pegs within the ERM simply weren't realistic for the U.K.'s economic circumstances and currency speculators placed huge bets on the notion that the country simply could not afford to maintain such an unrealistic rate. The pressure culminated on Sept. 16, 1992, when the British government stopped frittering away money, maintaining the rate (and fighting the speculators) and withdrew from the ERM. From a value of about 50.4 pence per dollar at the beginning of September, the value fell about 13% in one month and a further 15% by the end of the year.
Canada has never had an event like Black Wednesday, but it would be very wrong to assume that the loonie has had a stable run over the last two decades. Certainly the Canadian dollar has finished the last 21 years further removed from its starting point than the British pound; the USD/CAD exchange rate has moved from 1.171 to 1.02 in the last 21 years.
The 1990s and early 2000s were difficult for the Canadian dollar, as the exchange rate jumped from 1.171 to a peak of 1.60. Half of this move occurred between 1990 and 1995, a period in which Canada was posting troubling deficits and accumulating debt. In what will likely sound familiar to American readers, there were widespread worries about the sustainability of the Canadian system and potential credit downgrades.
While Canada had some relatively serious economic, debt and budgetary issues early in the 1990s, the country significantly cut spending and leveraged free trade agreements with the U.S. and Mexico to improve its situation. Certainly, it took time for the market to reward these improvements and the collapse of the tech bubble did not help. Nevertheless, the Canadian dollar has steadily gained on the U.S. dollar since early 2002 (apart from a roughly six-month reversal in late 2008) and has actually broken 1:1 parity a few times.
It would be misleading to credit the reversal in the Canadian dollar solely to the austerity programs of the late 1990s. Certainly, the country's growing resource trade with China and a healthier (though more highly-regulated) bank system has played a role, as well.
For all the talk of Japan's economic problems, the yen consistently strengthened between 1980 and 2011. A dollar bought almost 145 yen in January of 1990, but buys fewer than 78 as of 2012; a rather remarkable move in a market where 10% or 15% moves are considered quite large.
Certainly, this has not been a steady one-way move. While the yen got notably weaker early in 1990 (peaking around 158 yen per dollar), it then strengthened dramatically, reaching 85 to the dollar by mid-1995. Some of this movement can be tied to the last gasps of the Japanese asset bubble and, despite the cheaper U.S. dollar, cheaper U.S. exports did not ease the U.S.-Japan trade imbalance.
As Japan's post-bubble malaise set in, the fate of the yen got even more interesting. Japan pursued a zero-rate policy in an attempt to stimulate the economy and support its banks; that created a carry trade, where investors borrowed in yen and then purchased higher-yielding debt in other currencies. While the yen did soften between 1995 and 1998, the ongoing malaise saw the yen steadily appreciate against the dollar.
From its difficult birth in 1999 to 2011's uncertainties about its very survival, the history of the euro is short but far from boring. Established with a pretty optimistic value, the euro lost ground to the dollar and saw a 38% move in the exchange rate in that first year. From that peak, though, the euro has answered many of its skeptics and proven more resilient than initially thought. Even the sovereign debt crises of Europe have not wrecked the currency and the exchange rate as of 2012 stands about 15% below its starting point back in 1999.
It would seem that the strength of the euro throughout the 2000s may have been based at least in part on a fairy tale. Although the appearance of rigorous entry standards and German-style conservative monetary policy looked good, the reality is that several countries flat-out lied to get into the euro and exploited artificially-low rates to gorge on debt and delay economic liberalization. As of the beginning of 2012, it looks as though the strong states of the euro are committed to making the currency system work, but time will tell if the euro can maintain its relative strength against the dollar.
The Bottom Line
With financial and economic instability across the globe and the seemingly never-ending problems in the eurozone, currency rates are often uncertain. There are a few safe havens to invest in during times of turmoil, and many currencies work hard to maintain what strength they have. One thing is for certain: we will see more highs and lows in the future; the only mystery is which one we'll see more of.
By Stephen D. Simpson
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