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Arab Unrest and Forex, Part II

|Includes:FXCM Inc. (FXCM), GCAP
Or, the US$ is no longer the Manchester United of Currencies.
(thanks to football fan Andre R. for the analogy!)

During most political and military crises over the past century there has been an (understandable) flight-to-safety in the investment world. That has meant investors and traders bidding up the prices of:
  • Gold
  • the US Dollar and Swiss Franc,
  • US Government Short-Term Securities,
  • and of course Crude Oil, for crises involving oil-producing regions globally.
Much of this equation has held true the past couple of weeks since Egyptian President Hosni Mubarak resigned on February 11, inspiring a series of market- (and world-) jolting copycat uprisings in Libya, Bahrain, Tunisia, and elsewhere.

What has differed from past crises has been, however, the continued FALL of the US Dollar versus most major currencies during this time (e.g. now about 1.38 to the Euro, versus less than 1.35 at the outset of the crisis). As several of you have commented to us since we issued our first Arab Unrest and Forex piece on February 21, in “normal” times the US Dollar usually moves in the opposite direction of Crude Oil, leaving oil relatively stable in terms of other major currencies. Oil up, Dollar down. Oil down, Dollar up. But again, that relationship typically holds true during quiet times. In crises times when there is a flight-to-safety, usually both the US Dollar and safe harbor commodities often move up together.

Why has this not happened this time? Again, we offer several possible explanations. We would welcome your comments as well.
  1. It is over for the US Dollar. Without passing economic / financial judgment on the “real” strength and value of the US Dollar, from a perception perspective the US Dollar has lost its relative importance in the world, and is no longer the “Manchester United of Currencies”. It is not surprising that this has happened at around the same time that China has grown to surpass Japan as the world’s second-largest economy, and is rapidly closing in on the US. (Although in absolute terms China’s $5 trillion-a-year economic output still dwarfs the US’s $15 trillion, by several important measures China is now passing the US in total terms, such as “PPP” or Purchasing Power Parity, as pointed out by the Wall Street Journal.
  2. Fears of US Military Involvement. Although it seems reluctant to get directly involved so far, the market is at least in part discounting the future (military) involvement of the US in more far-flung parts of the world. The US government budget and deficit is stretched nearly as thin as it can get, and any more meaningful action and commitment by the US military – and the costs and drag on the US budget such action would entail – are sure to lead to more US deficits, money printed by the US Treasury, and thereby more long-term weakness in the US Dollar.
Again, we would welcome your comments on this topic.
Stocks: FXCM, GCAP