Translating Currencies through Gold

By Brad Zigler

Back in 1883, a 60-page language guide published in Britain became the object of so much hilarity that American wit Mark Twain sang its praises as the "perfect" work of humor. The tome, English as She Is Spoke, was intended to be a simple Portuguese-English phrase book, but instead became a masterpiece of unintended mirth.

The Portuguese authors intended to provide their countrymen with English words and phrases that could be used in travels to the British Isles, but they were beset with a trifling problem: Neither knew a lick of English.

Undaunted and possessed of a modest command of French, they set about their task by first translating a Portuguese-French conversational guide into English with the aid of a French-English dictionary.

You can imagine the result.

A query to be directed to a barber sums up the translation problem neatly: "Do you dress the hairs?" The ensuing recommendation for patter should give you pause the next time you converse with your own tonsorial technician:

Traveler: "Your razors are them well?"

Barber: "Yes sir."

Traveler: "Comb-me quickly; don't put me so much pomatum. What news tell me? All hairs dresser are newsmonger."

Barber: "Sir, I have no heared any thing."

Now, what on earth does all this have to do with hard assets?

Well, here at HardAssetsInvestor.com, we've written much about the relationship of commodities and inflation. Much of the discussion, too, has been dollar-centric since commodities are priced in greenbacks for world trade. The price for gold, as an example, is set in dollars at the London Bullion Market Association's twice-daily fixings.

That said, gold buyers are constantly making translations of their home currencies through the gold market, sometimes to surprising effect.

Look at gold's history over the past three years, priced in various currencies:

Using gold as a benchmark, the chart seems to indicate that its value has risen most in Yankee dollars over the past three years and the least in terms of Canadian loonies. Put another way, the Americans have inflated their dollars by the greatest degree; Canadians the least.

This may seem surprising to folk who don't live in border states or provinces, so we should check our math. To do that, we'll dust off a notion from Econ 101: the theory of purchasing power parity.

The theory states that exchange rates should equalize the price of goods in any two countries. Thus, gold can help us judge just how far currencies deviate from fair value. The implied purchasing parity price is the exchange rate that makes the U.S.-dollar price of gold the same in each country.

As of April 28, 2008, the market looked like this:

	U.S. Dollar ($)	U.K. Pound (£)	Switzerland Franc (CHF)	China Yuan (CNY)	Australia Dollar (A$)	EU Euro (€)	Canada Dollar (C$)
3-Year Gold Appreciation	104.9%	96.7%	77.9%	73.9%	70.5%	69.6%	66.3%
Interbank Exchange Rate	--	$1.9863	$0.9672	$0.1429	$0.9339	$1.5632	$0.9868
Implied Parity Price	--	$1.9853	$0.9663	$0.1425	$0.9329	$1.5622	$0.9859
Difference	--	0.05%	0.10%	0.32%	0.11%	0.07%	0.09%

When looked at from a current market standpoint, most of the world's major currencies are trading fairly close to parity, though all are a tad overvalued against the greenback. Most egregious is the Chinese yuan, which previously was the object of so much jawboning about its cheapness.

From this simple translation exercise-exchanging currencies through gold-we've found that the selling of dollars has been overdone a bit.

Not that I know who's been doing it, mind you.

"I have no heared any thing."

Comments

[dieuwer:]

The theory is flawed because it does not take into account transportation costs and tax law.

2008 Apr 30 10:36 AM

[Managing Ed...:]

Taxes and transportation cost differentials amounting to 32 basis points?

Got some numbers to compare?

2008 May 01 09:39 AM

[Managing Ed...:]

Gold is traded internationally, as are currencies, with global delivery points.

Work done by David Parsley, of Vanderbilt University, and Shang-Jin Wei, of the International Monetary Fund, indicate that prices for goods traded internationally converge towards purchasing-power parity quite quickly.

2008 May 01 01:01 PM