Currency Markets: Currencies in Transition – The Greenback’s Fall

After a strong decline in the U.S. dollar index over the summer, some industry experts declared the potential fall of the U.S. dollar (USD) as the world’s reserve currency.1

Why is the greenback losing its lustre? The significant stimulus injected into the U.S. economy has increased the money supply, which creates concerns about future inflation and puts downward pressure on the USD. With U.S. interest rates now at near-zero levels and the yield on U.S. government bonds closer to that of other developed nations, the demand for U.S. Treasurys may be waning.

Gold: The Rush Continues

A falling USD is likely one reason for the rising price of gold. Since the start of the year, gold has risen by over 35 percent, surpassing its previous all-time high of US$1,920 set in September 2011.2 Gold is a commodity, but it doesn’t follow typical supply and demand cycles for commodities as it isn’t consumed or used as an input in much other than jewellery. As it can always be traded for goods, it is considered a store of value as it holds its purchasing power during times of declining currency values or periods of high inflation.

A Rising Canadian Dollar

The Canadian dollar (CAD) has also benefitted from the falling USD, appreciating by over 10 percent since March when the price of oil fell to its lows.’ Will it continue its upward climb? Here is some food for thought:

The “Big Mac Index”, published by the Economist magazine, is a fun tool to make exchange rate theory digestible. It compares the purchasing-power parity (PPP) of global currencies. PPP suggests that over the long run, exchange rates should adjust so that an identical basket of goods/services costs the same in each country. Instead of using a basket of goods, it creates an exchange rate by comparing the cost of a Big Mac in a nation’s local currency to its cost in the U.S. Comparing this to the prevailing exchange rate determines whether a currency is considered to be under or overvalued. The bar chart shows the under/over valuation of the CAD versus the USD based on the Big Mac Index. The actual exchange rate is shown in green.

Currency fluctuations are a normal part of the financial markets. While a stronger CAD may provide better buying opportunities to purchase U.S. assets, for longer-term investors the impact of currency changes on returns has the tendency to even out over time.

  1. forbes.com/sites/simonconstoble/2020/06/19/the.recent•dropoin-the•dollar-is-only•the• beginning-says-goldman/#36bc61116983: 2. Yahoo Finance 12/30/19: $1,520.8/7/20: $2.063: 3. Bank of Canada. 3/24/20: 0.6901 USD, 8/19/20: 0.7593 USD.
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