While I am away, the Gary Scott messages each day contain a review from the course International currencies Made EZ. This information can help you understand why and how currency parities move. Here is a section from Chapter One. This report is dated but do not let the dates and numbers get in the way. The fundamentals remain the same.
The Urgent Importance of Global Currency Thinking
Less than a quarter of a century ago, the United States dollar was worth over 4.25 Swiss francs. If you had taken a fabulous skiing trip to the Swiss Alps at that time, $5,000 U.S. dollars could have been converted into 21,250 francs. As this report was written, the dollar was worth 1.28 Swiss francs. This means that the same $5,000 could be exchanged for only 6,400 Swiss francs. Now as the course is printed, the dollar is worth only 1.13 francs. Just in the few weeks it took to print this course the $5,000 lost another SFR750 and will buy now only 5,650 Swiss francs!
In less than 25 years, the dollar has fallen so much in value that it is now worth only one-quarter of its original exchange price.
Less than a quarter century ago, the dollar was worth 4.00 German marks. Now the dollar is worth less than 1.5 German marks (1.43 to be accurate). That means that a BMW that cost $20,000 now costs over $53,000 (all else being equal).
The dollar was worth nearly 400 Japanese yen twenty-five years ago. Now it's worth about 90 yen. The dollar is now worth less than one- quarter of what it was once in terms of the yen.
It's much the same with many other hard currencies, also. The value of the dollar has fallen continually, and as a result, at every stage of the fall foreign goods have cost more for U.S. citizens.
Take, for example, the cost of French wine. In 1971 a bottle of fine French wine might have sold in the U.S. for $20. In France the same bottle of wine sold for 400 French francs. The foreign exchange ratio in that day was, approximately, US$1.00 to 20 FrF. But today the exchange ratio is approximately US$1.00 to 5.3 FrF. That means the same wine, bottled by the same winery, now costs about $75 in the United States.
U.S. dollar French franc U.S. dollar French franc
$ 1.00 20 francs $ 1.00 5.26 francs
Price in U.S. Price in France Price in U.S. Price in France
$25.00 400 francs $75.00 400 francs
As the value of the dollar falls in relationship to any other country's currency, goods from that country become proportionately more expensive when purchased in dollars. This is true for wine, bread, cheese, cars, TVs, CD players, clothing, furniture, etc.
You may say, if you live outside the United States or if you live in the U.S., but buy American, “This doesn't affect me. I don't buy foreign products. I buy American when I can and pay for everything in U.S. dollars.” You may think that you only spend U.S. dollars.
But the complexity of international trade and economics today makes it impossible for you to not be affected dramatically by fluctuations in the value of the dollar compared with other currencies. In addition, all you will learn in this course about what happens to currencies applies to your currency as well as the U.S. dollar. The fate of the dollar as the reserve currency is linked to the fate of all currencies.
Take, for example, a U.S. resident who purchases a General Motors car, paying U.S. dollars. Nothing could be more American than a Buick or an Oldsmobile, right? But parts of every car today are produced in numerous countries. Every dollar you pay for the car is divided into segments and changed into many different foreign currencies — not by you, of course, but by someone.
You might pay $25,000 to the dealership for an American car, but several thousand of the dollars are converted to Japanese yen to pay for parts that come from Japan. A thousand or two dollars are turned to Korean won for labor and additional parts. Several thousand are converted to German marks for engineering work done in Germany. Additional thousands for design work might go to Italian lira, British pounds and Irish punts. Additional payments for engineering or labor might be sent to Canada, Hong Kong, South Korea, France, etc. And, if we go even deeper into the actual metallic, plastic and rubber components of the car, separate payments also might be sent to South Africa, Mexico, Saudi Arabia, Russia, Malaysia, Brazil, and so on.
In the end, less than one-half of the dollars you spend on this most American of products stay in America. Someone, acting on your behalf, converts those dollars into foreign currencies.
A person may say that he or she doesn't buy many products manufactured overseas, so why worry about currencies? The above example shows why every American is continually at the mercy of foreign exchange rates. It also shows why investors have to now understand both their own currency and the U.S. dollar.
The dollar has been falling in value for nearly two decades with the result that prices of products bought by Americans in dollars are rising steadily. This has continually eroded the purchasing power of the dollar and has made many products more expensive for every American.
Automobiles are only one example of this interconnected global maze. The gasoline you use for your car or to heat your home, the clothes you wear, the food you eat, the paper you use to write on, etc., all have components produced or purchased abroad, and have increasing prices reflecting the falling value of the dollar and other currencies.
However, other currencies have fallen versus the U.S. dollar, making goods and services from these countries less expensive to U.S. spenders. Yet this can be a problem too! Right now Mexico is a perfect example. With the collapse of the peso, credit card interest rates have soared to over 100%. Millions of middle class investors cannot make their debt payments. They have been losing their homes, their cars, their jobs and many have been protesting, even rioting in the streets. The short term future of Mexico looks grim. This is likely to increase the flood of illegal immigrants into the U.S. and add to security and social costs here. These added costs are likely to add to the U.S. debt which is one of the main reasons for the weak U.S. dollar.
Mexican bank bad debt ratios have risen to 9% (in the U.S. the rate is 1%) and it is reckoned that it could rise to 16%, causing Mexican banks to fail which in turn could cause another international monetary crisis. U.S. exporters of goods to Mexico have watched their sales almost dry up as Mexicans can no longer afford U.S. goods which have suddenly doubled in price. This means the U.S. global trade deficit will grow and could further weaken the dollar.
At the same time, many U.S. and Canadian industries are being ruined by cheap Mexican prices caused by the peso's fall. Take the Florida tomato growers. They are currently trying to sue Mexican tomato shippers to stop the flow of the cheap Mexican tomatoes that are flooding into Florida at prices below the Florida growing costs.
Only the most short term thinkers will see the fall of the peso as a boon to the U.S. or other nation that can now buy Mexican goods for less. Any clear thinker will see that economies around the world are now so related that bad news caused by a currency crash is bad news everywhere.
Currency fluctuations affect you and your family daily, and they affect you more profoundly every year. As we'll examine in this report, the dollar is falling in value and by all rights will continue to fall. This will tend to keep prices inflating. Purchases you make for your business and for your family's livelihood will continually be affected by the international forces of foreign exchange.”
Until next message, good investing!