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The Amero, The Bubble, and More
Greetings from Singapore! This week saw several records convincingly topped, one bubble preemptively popped, one currency unceremoniously dropped. Here we go!
How To Pop A Bubble
India's currency has had a spectacular run, and that country's BSE 30 stock index has climbed about 35% this year. Is this a coincidence, or is there a relationship between a strong equity market and a strong currency? While there are many variable factors, a hot stock market can attract capital from investors around the world. These investors must exchange their home currency for the currency of the market in which they wish to participate. For example, if I sell Brazilian stocks, I receive Brazilian Real in return. I then must exchange this currency for Indian Rupee if I wish to buy individual stocks of the Bombay Stock Exchange; essentially, I am selling the Brazilian Real and buying the Indian Rupee. If enough traders buy a currency (or a stock, or a commodity), that instrument begins to appreciate. Over $80 billion has poured into India so far this year, according to Morgan Stanley, driving the BSE 30 Index (also known as the Sensex, short for Bombay Stock Exchange Sensitive Index) to an all-time high, and launching the Indian Rupee into the stratosphere (see figure 1).
Figure 1: The USD yields to the much stronger Indian Rupee. Source: Saxo Bank
In order to prevent a stock market bubble and ease upward pressure on the currency, the Securities and Exchange Board of India (SEBI) floated a proposal to restrict foreign investment in India's equities market. The proposal hit the newswire on October 16, a Tuesday evening. The BSE 30 responded by opening with a spectacular plunge on Wednesday morning, tripping the circuit breakers just three minutes after the opening bell and diving 9% before battling back to close down by less than 2%. However, the sell off resumed in earnest on Thursday, with the Sensex falling 3.8%, and then dropping another 2.4% on Friday. It's interesting to note that the SEBI effectively defused a potentially explosive situation by merely suggesting these changes, as there is no imminent action on the horizon. The market's violent reaction demonstrates just how manic Sensex traders have become.
G7 Shrugs, Dollar to New Lows
Traders expecting the world's central banks to come riding to the rescue of the U.S. Dollar were woefully disappointed by the outcome of last week's Group of Seven (G7) meeting. The G7 statement simply reiterated that "exchange rates should reflect fundamentals", meaning that no action is planned to stem the slide in the greenback. The USD responded by hitting yet another new low against the Euro, breaching 1.4300 (see figure 2)
Figure 2: Euro reaches new high vs. USD after G7 meeting. Source: Saxo Bank
To add insult to injury, the International Monetary Fund, or IMF, opined last week that even after its recent plunge, the U.S. Dollar is "overvalued" at current levels. Ouch!
Question of the Week – The "Amero"
Q) Hi Ed, Having traded forex for quite some time now and make my daily living from it, I find your insight quite enlightening. I would love to hear your comments on the Amero.
Ed Ponsi) Thank you for your question. The Amero is a proposed currency union that would create one common currency for the U.S., Canada, and Mexico, in much the same way that many European countries now share a common currency, the Euro. It's important to note that the Amero currency is currently just a proposal from the private sector, and there is no current legislative push to make this concept a reality. In order to see if this idea makes sense, let's compare the proposed Amero with the Euro.
The European Monetary Union makes a good deal of sense because there were so many different currencies used in Europe prior to the introduction of the Euro. Ten years ago, a tourist visiting Europe might have needed German Marks on Monday, French Francs on Tuesday, Italian Lira on Wednesday, and so on. The expense and effort of constantly exchanging these currencies was a common and accepted part of this experience. Now think about businesses buying and selling goods across these European borders; they constantly had to monitor exchange rates and use financial instruments to protect or "hedge" themselves against unpredictable changes in exchange rates. The introduction of a common currency alleviated the expense and effort of this task, and companies experienced improved profitability as international trade was simplified by the use of a common currency.
Because it would initially encompass fewer currencies and a larger geographic area, the benefits of the Amero would be less dramatic. One proposal sees the Amero eventually encompassing all of North and South America, but the logistics of creating a monetary union between just the U.S., Canada, and Mexico seem daunting enough. For one thing, there is the issue of losing sovereignty over one's own monetary policy. The member countries of the European Monetary Union cannot set their own interest rates and must obey the edicts of the European Central Bank (ECB). Then there is the issue of national pride; many of my friends in the U.K. are staunch opponents of Euro adoption, and this is a sentiment that is widely held throughout that land. Great Britain would have to surrender the British Pound and accept orders from the ECB on interest rates if the Euro were to be adopted, and this is not a scenario that sits well with many in the U.K.
Do Canadians and Mexicans share similar provincial feelings? While the Mexican Peso has been a troubled currency, the Canadian Dollar is one of the current rocks stars of the currency world. In my opinion, Canadians would have to be barking mad to discontinue their autonomy and merge the Loonie with the woeful greenback. In case you missed it, the Canadian Dollar is now worth more than the U.S. Dollar (see figure 3).
Figure 3: Canadian Dollar continues its dominance over the USD. Source: Saxo Bank
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