USD: Why Is It So High?

On February 7th the ECB held their meeting whereby they decide on what the minimum bid rate is. This is similar to the FOMC meeting in the United States where the Federal Reserve decides what the FFR (Federal Funds Rate) aka the Overnight Rate will be. This is used to determine what banks and other institutions are charged from borrowing money from the Fed. After their meeting on February 7th the ECB held a press conference. During that press conference Mario Draghi, the President of the ECB stated “the euro’s exchange rate isn’t a policy target, we’re more concerned about price stability”, in other words inflation.

After he said this, the Euro dropped dramatically, the USD rose and the US markets fell due to the USD rising very rapidly. On February 7th, the USD was trading at 79.645 on February 8th it was trading at 80.125 and hasn’t been below the 80 mark since that time. In contrast the Euro went from a high of 1.3710 to a low of 1.29640 as of March 8th. So Mario Draghi got what he wanted: a lower exchange rate on the Euro.

Make no mistake about it. There is a currency war going on and it’s a race to the bottom, not the top. No region of the global economy wants a higher value currency as it means that the cost of goods from those nations will be far more expensive. If you need proof of this, take a look at the Japanese Yen. In September, 2012 it was trading at a high of nearly 1.300 to now a low of 1.0500. Nations that are either in a recession or perceived recession do not want their currencies higher; they want them low so as to stimulate sales of domestically produced goods and services.

The root cause of this war started in 2008 with the financial meltdown in the United States. This almost brought upon a worldwide depression economically. In 2009 the unemployment rate in the United States was at 10.1%. The next region to be effected by this was Asia. Why Asia? Well if manufacturing activities are shifted to China and the US isn’t buying goods and the United States is China’s major export market; the only result can be a slowdown. As the US economy improved, so did Asia.

There has been much debate in the United States concerning the European Contraction. This stems back to Maastricht Treaty of the early 1990's when it was determined that Europe would have one unified currency. Great Britain however was absent from this as they decided to go it alone with the British Pound Sterling aka the Gable. The thinking behind the Euro was that it would be easier to have one unified currency and additionally Europe, because of the closeness of borders wanted unified regulations in terms of transporting goods and services. In theory, this makes perfect sense. However what do you do when some nations aren't doing as well as others?

In 2010 with the first Greek Crisis, it appeared as though there are cracks in the foundation. Let's examine this. Greece as a nation doesn't have heavy industry to speak of, most of its raw materials have to be imported as they do not have huge natural resources to draw upon. It's major industry is Tourism, which is a nice-to-have but not essential. For those who are employed in government, they've enjoyed some of the youngest retirement ages on the planet. Greece has had 3 such dilemmas since 2010 and each time the EU has had to bail them out, much to the chagrin of the more powerful European economies.

Over time it was discovered that other countries were experiencing similar situations. Portugal, Ireland, Italy and Spain have all experienced economic downturns, some of which were economic and some related to Real Estate which had it's roots in the financial meltdown of 2008. Now I ask you, we live in a global economy; does anyone think that any one region of a global economy can escape an economic downturn? We used to able to do that. For example, the Asian Flu of the late 1990's was virtually unnoticed in the United States. But with all the trade the US does with Asia today, that is virtually impossible.

Enter Mario Draghi. Mario Draghi is the President of the European Central Bank (ECB) and is the equivalent of Ben Bernanke in the United States. In other words when he speaks about something the world takes notice. Europe is undergoing an economic recession with greater than 10% unemployment; at last count it was 10.7%. Mario Draghi wants a devalued Euro. Why? If the Euro trades at a lower exchange rate from other currencies it will mean lower prices for European goods and services. Lower prices means higher volume which leads to economic prosperity. For those who trade currencies you need to be very mindful of this. Look what happened in February when the ECB held a press conference. The USD went sky high in minutes after the conference and still hasn't come down to where it was prior to it. By comparison, this past ECB meeting had no such effect as the ECB got what it wanted: a lower exchange rate for the Euro.

Ultimately the consumer will decide who wins this war but one thing is certain; the consumer will not buy junk; they will not buy low quality.

Nick Mastrandrea is the author of Market Tea Leaves. Market Tea Leaves is a free, daily newsletter that discuses and teaches market correlation. Market Tea Leaves is published daily, pre-market in the United States.