There. Elegant and history-defying proof that "up" and "the euro" can be used in a single sentence. Nor is this merely linguistic legerdemain; any indication that the new monetary unit of that European subset of the Old Country has profound portfolio implications even for Americans who are not Eurocentric in heritage or perspective.
It's as simple as this: Where are you going to put your money? As stores of value, how do you like the lev, kip, loti or ouguiya? The foreign-exchange markets are full of funny names and funnier monies. As alternatives to the dollar, the world is now reduced to two -- begging your pardon, John Bull -- or stretching it, three. The British pound still punches above its economy's weight, but its political flirtation with the European Monetary Union (EMU) and the diminishing share of global GDP accounted for by the misty isles mean that the pound sterling has become part of the supporting cast and not a headliner.
China, in contrast, is potentially a major player, whether by China we mean the "one country, two systems" of the mainland, or the shy bride of Taiwan. Jointly or severally, China possesses international currency reserves, primarily U.S.-dollar-denominated, that are so large they begin to approximate its economic potential. But the political uncertainties involved in the renminbi and New Taiwan dollar are proportionately huge, and in any case, the currencies are so forcefully managed as to be, in effect, only semiconvertible.
Euro: A Technical Turn? Or the Big Fundamental Too?
Which brings us to the yen and the euro.
The yen is for you if you like to live dangerously. Its value in the marketplace is set by the interaction of several volatile and unreliable players. The
Ministry of Finance
alternately defends and deprecates the yen for reasons best understood by insiders. Cheap borrowing costs periodically attract the "yen carry trade," which periodically gets ravaged by sudden squalls of yen strength. There is the famously risk-averse and hugely liquid Japanese general public. With 100 trillion yen -- roughly $1 trillion equivalent -- maturing in the postal saving system in the next two years, Japan's savers will come face to face with their government's zero interest rate policy. To what extent will their desire for yield overcome their aversion to risk? How much of this money will be sent overseas, in the process pushing the yen lower?
Then there is the fact of financial fragility. The soundness of Japan's banks and insurance companies is suspect. They continue to be managed essentially by the same people who have made a science of buying at the top, with ongoing guidance from the same bureaucrats who helped them to achieve this record. Political stability? Sclerotic one-party rule, now about as reliable as the plate tectonics beneath the island itself. The yen is, however, backed by huge U.S. dollar reserves, but those reserves are generated through a highly charged, diplomatically sensitive trade surplus. If you like low yields and high betas, the yen is the currency for you.
So, back to the top. What's up with the euro? When we move from theoretical to real alternatives to the dollar, we arrive at a currency that is, for most of the world's people, still more theoretical than real. From its birthday on Jan. 1, 1999, it dropped by 25% against the dollar to a low of $0.889 one month ago. But in the past four weeks, it has recovered to a $0.931 value last Friday.
Big rally? No, but possibly a big deal. The euro's price behavior vs. the dollar has been something of a mystery. As Ernst Welteke, president of the Bundesbank, discussed in a
op-ed last week, the standard approaches to the relative valuation of currencies has not been at all helpful in explaining the euro's swoon against the dollar. Euro-area inflation rates are stable and a bit lower than those in the U.S.
Interest rates, which are moderately higher in the U.S., support the case for the dollar. But Mr. Welteke observes that there has been an asymmetrical foreign-exchange market response to information about the relative economic growth rates of Euroland and the U.S.: strong U.S. data tend to support the dollar, while strong Euroland data seem to be ignored. He concludes that there is an irrational trend-following herd behavior going on in the trading of euros against dollars and that this will eventually carry -- as it may already have done -- to a point that is ridiculous on the fundamentals. In short, the euro is now traded on a technical, not a fundamental, basis and will continue to be -- until the charts indicate otherwise.
Looking at the chart and considering technical factors, the euro now threatens to break the downtrend that extends back to the aborted rally high of $1.09 in October last year. If it does so, it's likely to precipitate a short-covering stampede to still higher levels as portfolio hedgers unwind the persistent short-euro positions that have been so steadily profitable. Forget the fundamentals; if what has worked stops working, go with it the other way.
But the fundamentals are ultimately what will matter to most of us, and the big fundamental has been relative economic growth rates: The U.S. economy has regularly outpaced that of Euroland -- and the rest of the world, for that matter -- and its currency has been strengthened as global capital has been drawn in to benefit from that differential growth.
Relative economic growth rates continue to support the dollar vs. the euro, but if the Fed is effective in slowing the U.S. economy, and if Euroland sustains its 1999-2000 growth acceleration, the fundamentals may swing the other way. If that happens, global capital will discover not a theoretical but a real alternative to the dollar as a store of value. The strong dollar has been an important, if not in fact the most important, factor in enabling excess demand in the U.S. to access foreign productive capacity while at the same time providing a cooling effect through "imported disinflation" and the price-suppressing effects of foreign competition on domestic producers.
Our markets are now fervently hoping for a well-modulated slowdown on this side of the water. That may indeed come to pass, but in my view, a slowdown in domestic demand is a necessary but not a sufficient condition to get the Fed off our backs. If slowdown here results in the big fundamental -- relative growth -- swinging in favor of Euroland, and if that produces a rally in euros which creates the reality of a practical alternative to the dollar as a global store of value, our markets will come to realize that the Fed will be forced to remain vigilant at the ramparts, slowdown or not. Be careful what you wish for.
Jim Griffin is the chief strategist at Hartford, Conn.-based Aeltus Investment Management, which manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at