The Dollar Doesn't Get Much Respect

by: Calafia Beach Pundit

If I've learned anything from our (quite enjoyable) vacation driving around Europe, it's that the dollar doesn't go very far.

As the above chart shows, from a long-term perspective the dollar is trading at relatively low levels, in inflation-adjusted terms, against two broad baskets of currencies. It's comforting to see that it is still about 5% above its all-time lows of mid-2011, but it is still over 10% below its long term average (96).

My calculation of the dollar's Purchasing Power Parity vis a vis the Euro is shown in the chart above (green line). This suggests that the Euro is about 20% overvalued against the dollar, which is another way of saying that things in Europe cost on average about 20% more than they do in the states. My real-life experience this past week in Germany, Switzerland, and Austria confirms what my PPP model tells me. (I have been using this model, by the way, since the mid-1980s.)

The strength of the Euro is likely one reason that eurozone inflation is quite low- low enough to draw the attention of the ECB, which appears to be gearing up for some kind of Quantitative Easing to forestall the alleged "risk" of deflation. With the ECB preparing to actively relax monetary policy at the same time as the Fed is preparing to begin tightening monetary policy (as soon as it finishes tapering QE3, which should happen by the end of this year), I think it's reasonable to assume that the dollar could enjoy some gains vis a vis the Euro over the next few years. The dollar could get a really serious boost if Washington could get its head out of the sand and pursue growth-oriented instead of business- and capital-unfriendly policies, but that awaits the outcome of the November elections at the earliest.

With the dollar generally weak against almost all countries these days (with the notable exception of the unofficial "blue" rate for the Argentine peso and the black market rate for the Venezuelan Bolivar, both of which are being crushed by a mountain of bad policies in general), I think it makes sense to engage in non-dollar investing on a mostly currency-hedged basis, because the long-term balance of risks favors, I believe, a stronger dollar.

Disclosure: No positions