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A $1 bill and a one-euro coin are worth almost exactly the same amount, for the first time in 20 years. The euro has traded above the dollar since 2002, but according to pricing sources tracked by Bloomberg, on Wednesday the euro, used by 19 nations, briefly fell below the buck, touching a low of $0.9998 before rebounding to $1.003 in afternoon trading in London. The dollar has been muscling higher against a broad range of currencies while the euro has been losing ground, especially against the dollar.
This is great news for Americans traveling to Paris because their dollars will buy more; it’s bad for Parisians heading the other direction. It’s good for European exporters because they receive more euros for every dollar of goods they sell in the United States; it’s tough on American companies that export to Europe or compete with imports from Europe.
You might wonder why the dollar is so strong even though inflation is high and a possible recession looms. (The Bureau of Labor Statistics reported on Wednesday that consumer prices rose 9.1 percent in the year through June, the largest 12-month change since November 1981.) High inflation, after all, tends to erode the value of a currency. And recession makes a currency less attractive by reducing the returns that 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 U.S. has higher interest rates, and the expectation is that they will go higher still in the coming months. International investors are willing to pay more for dollars to earn the higher returns on offer in the U.S. money market.
The European Central Bank could defend the value of the euro by raising interest rates as the Federal Reserve has, but it doesn’t dare to do so because the eurozone economy is more fragile. That’s partly because of the war in Ukraine, which is affecting Europeans much more than Americans. Energy costs in Europe have surged. The latest dip in the euro occurred in response to the shutdown for maintenance of the Nord Stream 1 pipeline, which supplies natural gas from Russia to Western Europe. Some Europeans fear that Russia will keep the pipeline closed to punish Europe for its support of Ukraine.
The dollar is also benefiting from the knee-jerk reaction of investors to put their money into dollar assets whenever there’s trouble, perceiving the United States as a safe haven. “Risk aversion and safe haven dynamics are the dominant driver” of the dollar’s value right now, George Saravelos, global head of foreign exchange research for Deutsche Bank in London, told me.
Although in theory a cheaper currency helps an economy’s trade balance, that hasn’t been the case lately for the eurozone, which is running trade deficits. Germany in May posted its first monthly trade deficit since 1991, the year after reunification. German exports are weak, and the prices of imports, including energy, have risen sharply.
For Germany, parity between the dollar and the euro “could not have come at a worse time,” Susanne Mundschenk, a founder and director of the news and analysis service Eurointelligence, wrote in an email. “Parity means imports become more expensive, driving up inflation further without solving any of the supply chain issues.”
For the U.S. Federal Reserve, the rise of the dollar is good, on the whole. It helps the bank achieve its goal of cooling inflation because a stronger currency holds down the prices of imports.
One finance 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 covered interest parity, doesn’t always hold in times of international financial distress.
Another way to tell 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 should be equally expensive in every currency, or else someone could earn guaranteed profits by buying it where it’s cheap and selling it where it’s expensive. In practice, purchasing-power parity doesn’t precisely hold, but it also can’t be violated too much for too long. According to the purchasing-power estimates of the Organization for Economic Cooperation and Development, “the dollar has not been this overvalued against the euro, sterling and yen in at least 30 years,” Marc Chandler, the managing director of Bannockburn Global Forex, wrote in an email.
It’s possible, then, that we’re seeing the bottom for the euro right now. Saravelos, for one, is predicting the euro will be back above the dollar by the end of the year if tensions ease in Ukraine or the Fed turns more dovish. That would be good news for a lot of Europeans.
Elsewhere: India to Surpass China
India will become the most populous nation sometime in 2023, topping China, the United Nations predicted this week. The U.N. also said that the world population is expected to “reach a peak of around 10.4 billion people during the 2080s and to remain at that level until 2100.” It predicted that more than half of the population increase by 2050 will be in eight countries: the Democratic Republic of Congo, Egypt, Ethiopia, India, Nigeria, Pakistan, the Philippines and Tanzania.
Quote of the Day
“Oh, I have three kids and no money. Why can’t I have no kids and three money?”
— Homer Simpson
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