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Five months after I wrote my first article on the Euro Vs. The USD, it looks like the U.S. dollar has won the match against the euro. Since April 2012, the euro has lost 5% against the dollar. Let's look at what has changed.

The following macroeconomic indicators have a significant influence on the strength of a currency:

  • Current account balance of the country
  • Total national debt of the country
  • Inflation rate
  • Interest rate

If the current account balance of the country is positive, a country will export more than it imports. As the population of the country exports more, they will receive more foreign money. This money will then be converted into their own currency, which is then spent or put in their banks. As the foreign money is converted into the money of the country's population, their own currency will appreciate in value.

The larger the country's national debt, the more expensive it will be to sell debt to foreigners. The government will then be obliged to monetize this debt to keep interest rates low. Rising debt will, therefore, result in a devaluation of the currency.

The higher the inflation rate, the lower the value of the currency. An example is Vietnam, where the dong lost much of its value due to high inflation.

When interest rates are lower than the inflation rate, there is no incentive for foreigners to buy the currency. There is no incentive to save money. The consequence is a lower value of the currency.

Let's look at the current statistics:

1) Current account
Five months ago, the current account deficit of the U.S. was on the order of $110 billion per quarter, which amounted to $450 billion per year (2011).

For the eurozone, the 12-month cumulative seasonally adjusted current account recorded a deficit of EUR 44.9 billion.

As of June, the eurozone posted a current account surplus of 14.9 billion euros, while the U.S. increased its quarterly deficits to $137 billion in the latest quarter.

So in this case, the eurozone is still the winner.

Europe vs. USA: 1-0

2) Total National Debt
Total U.S. national debt is $16 trillion. Total eurozone national debt to GDP is 88.6% -- the GDP is $17.578 trillion in 2011, which translates to $15.6 trillion in eurozone debt. So again, Europe wins by a small margin.

Europe vs. USA: 2-0

3) Inflation Rate
Five months ago, the inflation rate in the eurozone was 2.6%, while the inflation rate in the U.S. was 2.9%. Today, the inflation rate in the eurozone is 2.4%, while the inflation rate in the U.S. is 1.4%. This is a significant and surprising decline in the inflation rate in the U.S. vs. Europe.

Europe vs. USA: 2-1:

(click to enlarge)
Euro Area Inflation Rate
(click to enlarge)
U.S. Inflation Rate

4) Interest Rate
Five months ago, the interest rate in the eurozone was 1%, while the interest rate in the U.S. was essentially zero. As we already know, Mario Draghi lowered interest rates to 0.75%, but this is still higher than the interest rate in the U.S. (0.25%).

Europe vs. USA: 3-1:

(click to enlarge)
Euro Area Interest Rate
(click to enlarge)
U.S. Interest Rate

Conclusion: Europe still wins by 3-1 against the USA, but is losing ground through inflation. Still, I think the current account surplus of Europe is the most important positive indicator of the strength of the euro in the future. Therefore, I would short the U.S. dollar (NYSEARCA:UDN) and be long euros (NYSEARCA:FXE).

Source: The Euro Vs. The Dollar: Take Two!