The euro is falling against the dollar; France, and by extension the whole of
Western Europe, is wracked by rioting - variously ascribed to social, economic, cultural, and religious factors. Whatever the cause, the phenomenon is severe and spreading. The juxtaposition of these two phenomena, which are occurring simultaneously, virtually begs for a causative connection to be made: The rioting is feeding the weakness of the currency.
However, this hypothesis is supported by little more than fluff and hot air. Everyone is talking about the connection, so that it becomes a factor in the minds of traders, fund managers and the journalists and analysts who report and comment on their activities. In this way, it quickly becomes self-reinforcing and then self-apparent. This process has taken the idea of the rioting being the cause of the euro's weakness from being circumstantial to being obvious, to being common wisdom in the space of a week or so. Yet that doesn't mean it is actually true.
There are two ways of testing this connection. The first is to ask, "What would the dollar/euro exchange rate be, if there were no riots in France?" Like any "What if" question, this has no definitive answer. However, we know that the euro was weak against the dollar even before the riots began and that most analysts - particularly technical ones - were expecting it to weaken further.
It is quite possible that the decline would have been slower, or smaller, had the riots not occurred. That is equivalent to saying that the civil unrest acted as an additional factor, or maybe as a catalyst, within a trend that was already established. At most, therefore, the riots have been
a factor in the recent decline of the euro, but certainly not
the factor.
The second test is to see what happened to the currencies of countries where there were no riots.
Switzerland might have been considered a good example, or the UK, or
Sweden. In all these cases, the currency in question has fallen against the dollar. However, we will reject these on the grounds that they are all European countries and hence vulnerable, potentially if not actually, to similar problems. But what about
Japan? No restive Muslim minority there. But the yen also fell against the dollar, albeit less this week than last week.
In short, it seems probable that all the babble about investors selling euro out of fear of the impact of unrest/riots/violence/jihad/whatever, are massively overdone.
There has been little or no euro weakness. There has, however, been dollar strength - which is an entirely different phenomenon, whose causes are largely financial. The ongoing rise in US interest rates, discussed here last week, has created a growing spread between the return on holding dollars and that on all other currencies, bar those few whose rates are higher than on the dollar. But, there too, the advantage is rapidly narrowing.
Are we then to conclude that the markets are oblivious to what has been happening on the streets of France this past fortnight? Almost certainly not - but the proof is not to be found in the currency markets. Here the problem has always been choosing the less bad option - the dollar, which represents an economy plagued by huge deficits and driven by debt-laden consumers; the euro, representing a monetary union of countries unwilling to impose fiscal discipline and most of which are apparently incapable of reform or significant growth; or the yen, which is the manipulated currency of a deflation-ridden economy that no-one really understands.
This year, the markets have chosen the dollar as the least bad option because interest rates have risen and America's overall economic performance has been good. But the growing number of people who are uncomfortable holding any of the major currencies - indeed, who are uncomfortable period in the face of Bush's serial bungling and the prospect of Europe being engulfed in socio-religious civil wars - are turning to gold and other precious metals. That is why, for the last several months, the price of gold has ceased to move in lock-step with the euro. Even as the dollar has gained against virtually all the other currencies, gold has climbed - despite a bout of profit-taking a couple of weeks ago - to multi-year highs and seems poised to go higher.
landaup@netvision.net.il
