Euro Zone Financial Risk Webinar: Downside Risk or Growth Opportunity
This Euro Zone Financial
Euro Zone Financial Risk Webinar
"Our Euro Zone Financial Risk webinar today is on the eurozone debt crisis and it's specifically titled "Crying Wolf for the Eurozone." We've chosen this title because what we're trying to present here is a contrarian view on the eurozone crisis. It's one of the most disturbing crises that's been plaguing the world economy in recent times. Particularly over the last year to two years, there's been this mentality within at least the markets that's been now pervading into the business community that the end is very near.
The future forecast for the euro is the Deutsche Mark or the French Franc or something to that nature. What we want to do in this presentation is to allay some of those fears, while recognizing that the severity of the eurozone crisis is quite significant. With all of that said, I'd like to talk about today's agenda. We're going to start with an overview of some of the recent developments in the currency market, and also briefly touch upon the basic tools that currency analysts use for analyzing currencies.
Following that we're going to have a discussion on the meat of our topic which is going to be the eurozone debt crisis, how significant it has been, why it has been this significant, and a special discussion on some of the key participants of the crisis, including a discussion on Greece and Spain. Finally we'll be wrapping up this discussion with a discussion on how to hedge when it comes to this crisis.
Obviously, there are opportunities here and I know that all those opportunities contain quite a considerable amount of risk. It's quite important for business leaders and captains of industry to know how to circumnavigate these new waters, so that they can ensure the profitability built for their investors as well as for their employees.
Without further ado I'd like to get started with an overview of the trajectory of the U.S. dollar over the past decade or so. Here, what I've charted is something called the Trade Weighted U.S. Dollar, which is the value of the U.S. dollar against the basket of currencies rather than an individual currency. One of the main things that you can take away from this graph is that the value of the U.S. dollar has actually, sort of, entered a new period as of about July of 2008.
From early 2002 all the way until mid-2008, the U.S. dollar experienced steady and constant depreciation against the basket of currencies. This was largely due to two ever growing deficits in the United States and those were the fiscal deficit, and the second was the current account deficit, or the trade deficit that the U.S. was accruing with the rest of the world. During this time, you had demands for dollars dropping compared to an increase to demands for foreign currencies and that's why you had a drop in value of the U.S. dollar.
Now, since the onset of the global financial crisis, sometime in mid-2008, the value of the U.S. dollar and the product trajectory of the world's top reserved currencies has changed considerably. Gone are the days of steady and constant depreciation and hollow volatility. Volatility has been extraordinarily high for the U.S. dollar. For any participant who has any direct involvement in terms of currencies you can understand that at certain times of the year you might have up to a 30% change in terms of your currency payment values compared to other times of the year.
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How do currency analysts look at this and how do analysts really extrapolate the information? Well, there are a couple different ways and one of the main ways that used to be very prominent in terms of currency analysis especially for the U.S. dollar was to use the paradigm of gold. Gold used to be a great test for U.S. inflation rates as well as for the potential depreciation in the value of the U.S. dollar. This was due to two particular events in terms of histrionics of gold.
First you had the fact the U.S. dollar was actually based on the value of gold for an extended period of time and following that there was a period where gold was seen as a great hedge for the U.S. primarily due to psychological reasons. When you have this sort of triangle between the U.S. dollar, global currencies and gold in this particular triangle, if you ended up in a scenario where the U.S. dollar was depreciating, global currencies were stabled, it presented an opportunity for investors to use the triangle and appreciate the value of gold. Obviously the situation would work vice versa.
Since about three to four years ago, this particular relationship has not been very useful and there are two particular reason for that. First of all, the gold standard no longer exists and more importantly, the psychological boundaries that holding the relationship together have been slowly and steadily eroding. Second of all we have increased central bank activity within the gold market as central banks are amassing increased exposure to gold and this has fundamentally changed the supply and demand of gold.
That explains why a couple of years ago gold was trading at about $400 to $500 an ounce and now it's trading excess of $1700 or even $1800 an ounce. This is all despite the fact that the U.S. dollar hasn't considerably depreciated and neither have U.S. inflation rates considerably appreciated.
Now, taking gold aside, another way that you can analyze currencies is to look at this economic theory known as
While easy in theory, it's very difficult to apply in practice because of the fact that goods and services in one economy may not be offered in another economy and more importantly how that good is treated may be very, very different. Given the fact that neither gold or Purchasing Power Parody are very effective at explaining currency rates, the best way to really analyze currencies is to look at their fundamental interest rates and economic drivers.
To that extent there have been a couple of major economic developments over the past couple of years. Certainly, the slowdown in China has had a tremendous impact in terms of the global economy and certainly in terms of value of the U.S. dollar and the broader economy, and the broader industrialized world currencies. Chinese brokerage is certainly not growing at a double digit pace anymore, but nevertheless China has averted a hard landing.
The U.S. economy has been experiencing lackluster growth as of the global financial crisis and the looming fiscal cliff continues to be a source of significant frustration for market participants. This frustration has certainly felt by business at the end of the day who find it difficult to make long0term decisions given the fact that there are tremendous risks that lie just within a two to three-year basis.
Then, finally, one of the main things in terms of a pure financial event that has really changed a lot of things has been this recent growling in commodities and also its sell-off, which has affected a lot of commodity sensitive currencies such as the Australian dollar, New Zealand dollar and the Canadian dollar.
Now, taking all of these things aside, the eurozone debt crisis really stands apart. It's been one of the most significant crises that ever impacted the world economy. How significant has it been? Well, it's been alluded to in almost every single rate decision made by the industrialized central banks. These include Australia, New Zealand, Japan, the U.S., Canada, the Scandinavian countries, the individual central banks within the eurozone for sure.
The fact that it's actually been alluded to by all these central banks is quite significant, because central banks in the end of the day tend to be relatively selfish institutions that are primarily concerned with the economic developments within their own jurisdictions. The fact that these central banks are actually considering exogenous influences on their economy from the eurozone is testament to how much central banks are willing to go outside their jurisprudence to really ensure that they have a comprehensive picture of what's going on.
Another way to gauge the significance of the crisis has been the fact that it's been a key driver of volatility within the equity markets. For any major market participants with exposures to equity portfolios, or who's managing a company that has outstanding shares trading in the equity market, I'm sure you can understand that earnings announcements are no longer the primary reason for changes in values of equities. Certainly the changes in what's going on in the eurozone do have a considerable impact in terms of undulations of equity values and share prices.
Exaggerated changes in sovereign interest rates are a third way in which you can detect how significant the eurozone crisis has been. At certain times of the year, certain countries have interest rates fluctuating by a factor of two or event three, because of the various changes that are happening in the eurozone. These are some of the macro reasons where why, or how significant the crisis has been.
To understand how significant the crisis has been on a more micro scale and for how it's been particularly important corporate..."
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