Sunday, 14 November 2010

why the US Dollar

Anyone with a passing interest in finance (seems to be more people today) will notice (perhaps) that we always use the US Dollar in comparisons.

It would seem to be the basis of all comparisons. There is some historical reason for this, but in a nustshell it essentially boils down to the USA being the last big boy standing after the all out brawls of WW1 and WW2 were over.

The USA could step in and say we hold the cards. Its a simplification but more or less supported by a number of views. Have a quick look at the history of the Bretton Woods Agreement at Wikipedia here, but a quick potted history from wikipedia is:

Preparing to rebuild the international economic system as World War II was still raging, 730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, for the United Nations Monetary and Financial Conference. The delegates deliberated upon and signed the Bretton Woods Agreements during the first three weeks of July 1944.

Setting up a system of rules, institutions, and procedures to regulate the international monetary system, the planners at Bretton Woods established the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), which today is part of the World Bank Group. These organizations became operational in 1945 after a sufficient number of countries had ratified the agreement.
Well anyway ... it was all going well for them till the USA itself (embroiled in a costly campaign in Vietnam) pulled out the main pin with the Nixon Shock of removing Gold from being the governing commodity for the US currency.

So apart from habits (and they really do die hard) there is really little to tie us to use the USD as a currency comparator.

Back when I first went to the USA the price of the US dollar was actually less than the Australian dollar. For one reason or another the Aussie was floated by Paul Keating in 1983 and we have been gradually working out it worth since then.

For the last number of years however the USD has been falling against with AUD, the US Sub-prime crisis seems to have shown a significant fall in the USD (seen as the spike below)

... that more or less has settled out and we're back to the regular fall in value we've seen over the last 5 or so years.

The EURO on the other hand has been more resilient to the USD issues. Tere have been some fluctuations up and down as the exposure to high US Dollar exposure was worked out (as well as some internal crises such as Greece).

Over all however the US Dollar has fallen from 85 EURO cents in the end of 2005 to be about 72c now. Representing a long term failure.
So when comparing the Australian Dollar to the EURO we see a more steady and even happening. The value has moved up from being worth 60 cents in 2005 to about 71cents.

To some extent I have felt that in the period from 2002 to 2008 the Aussie was undervalued. The market had not see the or understood commodity boom with China and the confusion of the sub prime crash in and around 2008 led to international uncertainty, but now we seem to be steadily moving away from these problems and being seen as we are (for what we are worth).

Good as Gold?

The use of Gold as a standard to determine currency has a long history, in fact its more illuminating when and why we have moved away from it. For example from this article we see the following points:
Governments faced with high levels of expenditure, but with limited sources of tax revenue, suspended convertibility of currency into gold on a number of occasions in the 19th century.

the US government did so during the US Civil War

As in previous major wars under the gold standard, the British government suspended the convertibility of Bank of England notes to gold in 1914 to fund military operations during World War I

When you look at the increase in value of Gold against the US Dollar it looks like its gone bezerk. The interesting thing however is when you compare it .

In the graph below (sourced from I have altered the scales on the EURO by scaling the height of the graph. Both started from being worth about the same (4oo currency units)...

while the US has risen to being around 1500 currency units (dollars) the Euro is only fetching 1100.

So the moral of this post is that if you're wondering about how well you're doing, don't compare yourself to the US Dollar anymore. Because its falling, if you're on parity then you're falling too.

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