With the European Union (EU) announcing a $1 trillion bailout package for the euro last week, global currencies are back in the headlines. With daily turnover exceeding $4 trillion, the volume of currencies traded on world markets is ten times that of stocks. The world’s most famous currency trade — a bet against the British pound in September of 1992 — netted speculator George Soros more than $1 billion.
Thanks to the recent advent of currency exchange-traded funds (ETFs), the formerly mysterious world of currency trading is now as accessible to you as investing in Apple or Walmart. Over the next few weeks, I’ll be exploring the prospects for three different groups of global currencies — reserve currencies, the currencies of other developed markets, as well as those of the BRIC economies — all of which can help you to generate big profits in global financial markets. But realize that 97% of the world’s currency reserves are in the top four currencies: the U.S. dollar, the euro, the British pound sterling and the Japanese yen.
The U.S. Dollar
The U.S. dollar is by far the most widely held reserve currency in the world today, 61.5% versus 28.1% for the euro. That means the United States has the currency deck stacked in its favor — unfairly in the eyes of some. Cassandras have called for the imminent demise of the U.S. dollar for years. In their view, soaring U.S. budget deficits, combined with a creeping European-style social welfare system under the Obama administration, confirm that over the long-term, the U.S. dollar is going to hell in a hand basket.
For all of its problems, the U.S. dollar remains the favorite reserve currency because it has stability, scale and liquidity. And when risk appetite wanes, investors rush to the U.S. dollar. And current economic prospects for the United States are the strongest when compared to Europe, Japan and the United Kingdom. In Q1 of 2010, the U.S. economy expanded at a rate of 3.9%, while Europe stagnated at 0.5% and the United Kingdom barely budged with a growth rate of O.1%. The “least ugly” among the world’s reserve currencies, there’s good reason to think the U.S. dollar will remain strong.
For a while, the euro was on a helluva roll. By its seventh birthday in 2006, the value of euro notes circulating worldwide overtook the value of U.S. dollar bills. The model Giselle Bundchen reportedly demanded payment in euro and U.S. rapper Jay Z was flashing euros around in his videos. By September 2007, former Federal Reserve Chairman Alan Greenspan said that the euro could replace the U.S. dollar as the world’s primary reserve currency.
How things have changed. Less than three years and one global financial crisis later, headlines are echoing Milton Friedman and predicting the euro’s demise. Even before Greece revealed the full extent of its fiscal woes, the euro had taken a pounding and dropped from a high of around $1.60 in 2008 to about $1.23 recently. And a bet on the collapse of the euro to fall to parity with the U.S. dollar is the “career-making trade” at the world’s top hedge funds.
The British Pound Sterling
The United Kingdom’s pound sterling was the primary reserve currency for much of the world in the 18th and 19th centuries. But thanks to the increasing dominance of the United States in the world’s economy, the sterling lost its status as the world’s reserve currency over the past 100 years.
More recently, the United Kingdom’s soaring budget deficit and fiscal crisis have put the British pound sterling on the defensive. From the lofty heights of $2.10 to the U.S. dollar in 2007, the sterling fell by a third to around $1.38 in 2009. With the British currency trading around $1.44 to the U.S. dollar, it may retrace that level again in 2010.
That’s not surprising. The U.K. government’s fiscal deficit rivals that of Greece. The U.K. government spent massive amounts to stimulate the economy and bail out banks. Public and private indebtedness is soaring. Government entitlement programs have spiraled out of control. Last year, Standard & Poor’s lowered the United Kingdom’s rating outlook to “negative” from “stable.” The British economy has barely edged out of recession in 2010. Jim Rogers has predicted that the pound will collapse to close to parity with the dollar. Whether you agree or not, it is hard to imagine — its new coalition government notwithstanding — that there is much good news for the pound sterling.
The Japanese Yen
When global investors flee for safety, one of the first places they escape to is the Japanese yen. During the collapse of global financial markets in 2008, the Japanese yen was the greatest safe haven. Every time global stock markets would fall, the Japanese yen would rise.
Given that Japan’s debt problem dwarfs that of Greece, some investors are left scratching their heads. But those who have bet against the yen have had those very same heads handed to them. Bulls argue that after 20 years of virtual stagnation, Japan is due for a comeback; the yen is better positioned today than its European rivals. They seem to have a point. Rising 30% against the U.S. dollar, the yen has quietly become the single best-performing major currency over the past three years.