A $1 bill and a one-euro coin are worth nearly exactly the same amount for the first time in 20 years. The euro has been trading above the dollar since 2002, but according to price sources followed by Bloomberg, on Wednesday, the euro, used by 19 countries, fell short below the dollar, reaching a low of $0.9998 before returning to $1.003 during afternoon trading in London. The dollar has strengthened against a wide range of currencies, while the euro has lost ground, especially against the dollar.
This is great news for Americans traveling to Paris as their dollars will buy more; it’s bad for Parisians going the other way. It’s good for European exporters because they receive more euros for every dollar of goods they sell in the United States; it is tough for US companies exporting to Europe or competing with imports from Europe.
You may be wondering why the dollar is so strong while inflation is high and a possible recession is looming. (The Bureau of Labor Statistics) reported on Wednesday that consumer prices rose 9.1 percent in the year to June, the biggest change in twelve months since November 1981. After all, high inflation tends to erode a currency’s value. And recession makes a currency less attractive by reducing the returns investors can expect on their investments.
The explanation? It’s all relative. The United States has inflation, but so does Europe. The difference is that the US has higher interest rates and is expected to go higher in the coming months. International investors are willing to pay more for dollars to achieve the higher returns in the US money market.
The European Central Bank could defend the euro’s value by raising interest rates, as the Federal Reserve has done, but is afraid to do so because the eurozone economy is more fragile. This is partly due to the war in Ukraine, which affects Europeans much more than Americans. Energy costs in Europe have risen. The latest dip in the euro came in response to the maintenance shutdown of the Nord Stream 1 pipeline, which supplies natural gas from Russia to Western Europe. Some Europeans fear that Russia will do that keep the pipeline closed to punish Europe for its support of Ukraine.
The dollar also benefits from the reflexive response of investors to put their money into dollar assets when there are problems, viewing the United States as a safe haven. “Risk aversion and safe harbor dynamics are the dominant drivers” of the dollar’s value right now, George Saravelos, global head of Foreign Exchange Research for Deutsche Bank in London, told me.
While in theory a cheaper currency benefits an economy’s balance of trade, recently that has not been the case for the eurozone, which is running trade deficits† Germany placed its first in May monthly trade deficit since 1991, the year after reunification. German exports are weak and prices of imports, including energy, have risen sharply.
For Germany, the parity between the dollar and the euro “couldn’t have come at a worse time,” Susanne Mundschenk, founder and director of the Eurointelligence news and analysis service, wrote in an email. “Parity means imports become more expensive, driving inflation further without solving supply chain problems.”
For the US Federal Reserve, the appreciation of the dollar is generally good. It helps the bank achieve its goal of cooling inflation, as a stronger currency keeps import prices low.
One financial theory suggests that when interest rates are higher in the United States, you should expect the dollar to lose ground in the coming months. Otherwise investing in dollars would be a free lunch. But that condition, known as secured interest rate parity, doesn’t always hold in times of international financial distress.
Another way to determine whether a currency is fairly valued is to compare its purchasing power with that of other currencies. An item such as a pound of copper would have to be equally expensive in each currency, otherwise someone could make a guaranteed profit by buying it where it is cheap and selling it where it is expensive. In practice, purchasing power parity is not exactly true, but it cannot be violated too much for too long either. According to the purchasing power estimates of the Organization for Economic Co-operation and Development, “the dollar has not been so overvalued against the euro, sterling and yen in at least 30 years,” wrote Marc Chandler, the director of Bannockburn Global Forex. in an email.
So it is possible that we are now seeing the bottom for the euro. Saravelos, for example, predicts that the euro will rise above the dollar again by the end of the year if tensions in Ukraine ease or the Fed calms down. That would be good news for many Europeans.
Elsewhere: India overtakes China
India will become the most populous nation sometime in 2023, surpassing China, the United Nations predicted this week. The UN also said the world’s population is expected to “reach a peak of about 10.4 billion people in the 2080s and remain at that level until 2100”. It predicted that more than half of the population increase by 2050 will occur in eight countries: the Democratic Republic of the Congo, Egypt, Ethiopia, India, Nigeria, Pakistan, the Philippines and Tanzania.
Quote of the day
‘Oh, I have three children and no money. Why can’t I have children and three money?”
— Homer Simpson
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