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Part II: The U.S. Dollar and the Thief in the Night
It seems that last week's newsletter struck a nerve with many of our readers, who want to better understand the problems confronting the U.S. Dollar and how they affect the wealth, savings, and future of U.S. citizens. Thanks to all of you for your emails, your questions, and especially your concerns. It is vitally important that we understand the nature of the problem in order to understand the possible solutions. I received a variety of questions from you, including requests to explain the U.S. Dollar Index (USDX) in greater detail, so let's begin there.
The USD Index measures the performance of the U.S. Dollar vs. a basket of currencies. This basket consists of the following currencies: Euro 57.6%, Japanese Yen 13.6%, Great Britain Pound 11.9%, Canadian Dollar 9.1%, Swedish Krona 4.2%, Swiss Franc 3.6%. The Euro comprises a large segment of the basket because it replaced the West German Mark, the French Franc, the Italian Lira, the Dutch Guilder and the Belgian Franc, all of which were formerly represented in the index prior to the introduction of the Euro (see figure 1).
Figure 1: A breakdown of the components of the U.S. Dollar Index. Source: Akmos.com
The USD Index gives traders a general indication of the strength or weakness of the U.S. Dollar in much the same way that the S&P 500 Index gives traders an indication of the strength or weakness of U.S. stocks. As you can see from the chart, the collective basket is beating the tar out of the U.S. Dollar (see figure 2).
Figure 2: USD Index reaches yet another 15-year low. Source: FX Street
How Did We Get Here?
Those who forget the past are doomed to repeat it. Make no mistake about it; this ominous chart of the USDX represents the value of every U.S. Dollar you have worked for, saved, and invested. To hold all of your wealth in U.S. Dollars – which is exactly what most Americans are doing, perhaps without even realizing the consequences – is similar to holding all of your wealth in a poorly performing stock. This is why it is now so expensive for Americans to travel overseas, but that is just one obvious symptom of a problem that could have far greater consequences.
Those of you who remember the 1980's may recall a time when investors from Japan purchased many parcels of U.S. real estate, including the much-publicized sale of a majority stake of New York City's famous Rockefeller Center to Mitsubishi Bank in 1989. In the years preceding this sale, the U.S. Dollar lost about half of its value vs. the Japanese Yen, falling from a value of 262 Yen in early 1985 to 121 Yen in late 1987. This USD weakness made the purchase of Rockefeller Center, along with other parcels of U.S. real estate, exceedingly cheap for Japanese investors (see figure 3).
Figure 3: US Dollar falls hard vs. the Japanese Yen in the 1980s. Source: Saxo Bank
The Rockefeller Center purchase was considered a watershed event, and at the time, the ire of many in the U.S. was misdirected toward the Japanese. While this event brought many xenophobes out of the closet, in my opinion there is nothing wrong with Japanese investors or anyone else buying U.S. property; my concern is that U.S. investors will be unable to reciprocate. If you are the type of person who is upset by the prospect of foreign investors from Japan, Europe, or the U.K. buying up U.S. real estate and companies, ask yourself why. After all, are people in those countries responsible for the current weakness in the U.S. Dollar?
The answer is a resounding "no". The defiling of the U.S. Dollar is not something that occurs outside of our borders, it has been happening and continues to happen right here in the U.S. It's time that we took responsibility for our own currency and demand that our public servants implement policies that actually support a stronger U.S. Dollar, instead of just paying lip service to a non-existent "strong dollar policy". My concern is that we may be entering a time when we will see the already weakened U.S. Dollar become diluted even further, making U.S. real estate affordable to just about everyone other than U.S. citizens, at a time when many Americans face the prospect of losing their homes. Expect to see a resurgence of buying activity from overseas investors if the USDX continues to fall.
Why Are We Sleepwalking?
Even as it loses its luster, the U.S. Dollar is still the world's dominant currency, and because of this, people in other countries are keenly aware of the value of their currency vs. the greenback. I recently returned from Toronto, where news programs closely monitor and report the value of the Canadian Dollar vs. its U.S. counterpart. The "Loonie" and the greenback are rapidly approaching parity, the point at which one Canadian Dollar will be equivalent to one U.S. Dollar. Just five years ago, the U.S. Dollar was worth 1.6 Canadian Dollars. The rapid ascent of the Canadian currency vs. the U.S. Dollar is a source of pride for many Canadians, and rightly so (see figure 4).
Figure 4: USD falls hard vs. the Canadian dollar. Source: Saxo Bank.
On my frequent travels to the U.K., I am often asked for real estate tips from Londoners who want to buy a piece of the American dream. Who can blame them, since we are willing to sell our dreams so cheaply? It seems that the collapse of real estate prices in southern Florida, especially in Miami, is attracting quite a bit of interest from Europe and the U.K. After all, a flight from London's cold winter to sunny southern Florida takes just nine hours. Now that one Great Britain Pound is worth nearly twice the value of a U.S. Dollar, and there is a glut of available condos in the Miami area, expect to see more of our friends from the U.K. at the beach next year.
People in many foreign lands possess a greater awareness of exchange rates compared to Americans out of sheer necessity. Imagine growing up in Europe prior to the introduction of the Euro, where the German Mark, the French Franc, and many other currencies existed within a relatively small geographic area. In such an environment, it would be necessary to constantly monitor exchange rates for purposes of travel and commerce. In contrast, U.S. citizens live in a "single currency" culture, where most of us do not deal with exchange rates on a constant basis, and only become aware of the acute weakness of the dollar when we travel overseas. This lack of awareness is a big part of the problem, and now that we have addressed it, I'd like to offer my suggestions for improvement. Please be sure to read next week's column for the third and final part of this series.
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through