Now onto the lesson:
A recent major currency review lesson looked at how to value currencies by analyzing government debt and trade balances. That study highlighted the Danish kroner as a strong major currency to hold right now.
Yet there is more analysis to do in determining a currency’s strength. The second analysis relates to inflation and inflation potential. Currency parities tend to shift relative to inflation. If one currency as zero inflation and another 10%, the high inflation currency is likely to drop 10% versus the currency with zero.
Let’s see why. Assume for example that it takes US $1,000 to buy an ounce of gold. Let’s assume that the US has 10% inflation so in a year it will take $1,100 to buy an ounce of gold.
If the US dollar is worth 5.60 Danish kroner the $1,000 buys 5,600 kroner. So it takes DKR5,600 to buy an ounce of gold. If Denmark has zero inflation then in a year it will still take DKR 5,600 to buy an ounce of gold. So in a year 5,600 dker will be worth $1,100 or about 5.10 kroner down from 5.60 kroner.
This is the theory. Rarely (especially on a short term day to day basis) will currencies accommodate this theory exactly. Long term this is a good guide.
So how can we measure inflation and potential inflation?
Once again we can turn to Economist.com and look at the Output Prices and Jobs Data.
You can get update data by clicking on:
Economist.com> Market & Data > Weekly Indicators > Under Indicators >
Output Prices & Jobs.
The most current data when this lesson was written was February 26, 2009 and looks like this. Since this reproduction is not very readable here, I have reproduced the data we are seeking from this chart below.
For this study all we want to see is the consumer price increase for 2008. This is the rate of inflation in that country for 2008. Since all we are looking at are the major currencies, here they are from the February 26 chart above:
Country Consumer Prices
New Zealand 3.7
Last lesson we looked at interest rate – governmental budget balance – trade – current account balances and the last year’s rise or fall versus the US dollar.
We saw that the Danish kroner had a very high interest rate compared to most of the major currencies…especially the euro… 4.50% versus 0.27% for the US dollar and 2.12% for the euro.
Denmark has a positive budget surplus and positive account balances that could strengthen its future parity.
Plus the Danish kroner has dropped a lot versus the dollar, this last year.
January 28, 2008 a dollar bought 5.05 kroner. Now the greenback is worth 5.63 kroner so the kroner looked like a good value in the first four tests.
The Danish kroner has higher interest… a balanced budget… and positive trade and current account balances… plus it has been falling versus the dollar.
This is what I look for… value… a currency that is down when all its fundamentals are up.
Now the kroner does well in inflation also ranking fourth behind Japan, Switzerland and Canada.
Now let’s look at the four fundamentals we previously examined for these four currencies that rank well on inflation.
Current Account % of GDP
Budget Balance % of GDP
Parity to US dollar
Denmark – 10%
Switzerland + 4%
Denmark still ranks quite well. Now we can be thinking that two currencies offer good fundamental value… the Danish kroner and Canadian dollar.
The downside of the Canadian though is the low interest rate. Perhaps some Canadian bonds would make sense.
The July 17 2012, 5.25% EUROFIMA Supranational Bank bond denominated in Canadian dollars is selling at 108.46 for a yield of around 3.10%… not awfully exciting but an indicator to search around and talk to your financial planner about.
Bond spreads have been very high so be careful not to buy something you cannot hold until maturity.
We are not done look at inflation. Next lesson will take the next inflation step.
Even though we use this analysis we still diversify because these are confusing times for many investors.
A bit of simple logic can help clear away the fog… because life…and hence economics… up and down… is orderly.
We cannot always predict the exact position of this order in what appears to be disorder… but we can understand the nature of order and make assumptions that are reasonably certain.
James Gleick, a science reporter for The New York Times, wrote about this in his book “Chaos”. He used weather, stock market and fluid dynamics forecasting as examples of understanding the orderliness in chaos.
The weather, he wrote, is created by the earth’s atmosphere, which consists of familiar simple gases and water vapor, is nothing but a complicated mechanical system of a kind that should be calculable by the familiar rules of mechanics, he wrote. Knowing its state at one instant – say now – it should be possible to calculate its condition at some future instant – say in 10 minutes or even 10 years.
Yet such predictions elude mankind. Numerical weather forecasting is valuable but meteorologists can hardly hope to do better than a 10- or 14-day forecast by computer.
We never know what will happen with the mountain weather here in Cotacachi for example. These photos taken from our condo show that some times the mountain is clear.
Then moments later it disappears behind clouds… nobody knows.
The innumerable weather patterns created by mountain meeting air defy exact prediction. However the assumption created by this sunrise over the mountain is…
Red in the morning, shepherds take warning.
Gleick calls the answer the paradox of the butterfly’s wings that says there is an infinity of potential weather that is beyond Man’s ability to measure.
Really small differences in the starting points of mechanical systems can lead to huge differences in their conditions some time later. Nobody can be sure that a butterfly somewhere does not cause a disturbance of the atmosphere that when magnified with the passage of time becomes a hurricane somewhere else.
This leads us to fractals, which are the small parts… the starting points of systems such as an economy, stock or currency market.
Ours is a fractal universe… fractal world… with fractal manifestations reated by fractal molecules.
The late Michael Crichton’s book “Jurassic Park”, explains this when one of the heroes says: “Fractals are everything!” – meaning that all of the creation, from macrocosmic scale down to quarks follows the same rule of organization. A rock resembles larger pieces of rock in its structure and form, and ultimately it
looks pretty much like the mountain that it is forming.”
Every part of existence… and hence all economies are built of smaller and smaller and smaller, but similar parts. Hence the saying, “as above.. so below.”
So an economy built by fat sick people… living in a fat sick society will tend to be a fat, sick economy.
This allows us to make some assumptions… that… we can be fairly certain of.
Nature abhors a vacuum. Thus nature abhors too much fat. Nature is efficient and stores energy everywhere. If there is too much energy in one place (fat is just stored energy) and not enough in another… there will be an energy exchange. We see this all the time… wind… lightening… flood… heart attack.
If nature abhors a vacuum it means that nature abhors excess as well.
So, when an economy gets too rich… when a person becomes overweight… when the atmosphere fills with water vapor. Everything slows down… there is resistance… there is vulnerability. There will be change that equalizes the situation.
We watch this on the coast where the ocean (instead of the mountains) meets the air. One moment our beach will be hot and crystal clear.
This is a guarantee that clouds will soon appear and most of the sunbathers will disappear!
Yet when the rain comes… we cannot predict exactly. However a common wisdom is correct here also. The fishermen will be ready when they see this sunset shot I took at our Vistaazul condos because…
Red at night… sailors delight!
Here they go… next morning heading with confidence to sea.
Currecnies are the same way. In the short term we canot predict ow their parities will move.
Long term though we can get a better feel.
One investment manager I know states this common wisdom simply by saying, Periods of high performance are always followed by periods of low performance.
Because the Western mindset is dominated by a linear rising view… the Western economic model runs on rising expectations. The entire economic revolution that started late 1700s has been fueled by expectations of better lives ahead. Farmers moved to factories and sweatshops. They saved, educated their children who expected even more from value added careers. Nation after nation grew better. giving the less attractive lifestyles to poorer countries.
Yet a liner upwards continuum is not nature’s way. High performance is the result of low performance. Life is an up and down process so the false expectations of humanity leads society to place demands on elected leaders to violate the laws of nature… to add layer after layer of fat.
Humans can delay some universal forces changing the timing but not the overall results. For example the chart of the Dollar adjusted Dow below which I refer to often shows 1998 was a year when markets should have had an economic correction.
1920 to 1945 was one cycle. Over exuberance(too much fat) in the 20s led to a mid cycle crash. 1945 to 1968 was the next. This cycle ended in the early 1970s when Western countries experienced an economic recession. This was blamed on oil embargoes. The reality was it was time for an economic fast. The next cycle that began after the 1970s recession should have ended with a downturn around 1998.
Yet societies propelled by expectations of upwards only lowered interest rates and took steps to create a real estate boom…pushing up paper prices and creating the illusion of greater wealth… a bubble… that took a 10 years to bust.
We are now paying the price of that ten year extension.
This downturn differs from the correction of 1932. That correction took place when the economy should have been on the rise. The correction came just because the upside rose way too fast.
This correction may be less harsh because it is simply the downside catching up. The economy may now be below where it should have been had the correction not be delayed.
This thought enhances my recent suggestion to do nothing in shares now.
We may well be near the bottom. Sell now ad you may miss the recovery plus you’ll sell when spreads are high thus losing even more.
Instead seek value in sales short term bonds in strong currencies. This is why we are studyng how to deermine value in currecnies.
Until next message good global investing!
One of the best ways to prosper in this downturn is with your own internet business. You can enroll in our email internet course here for $299. However if you sign up for all three courses in June or later in 2009, I’ll send it free. You save $299. Learn more here
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May 29-31 JGAM Florida Investment Course
In the shamanic mingo you will learn how the concept of fractals is part of the ancient sacred geometry that leads us to where we should be. The shamans belive that the mountain we grow up viewing is our mother (Pacha Mama) who guides us on our life’s way.
This never made much sense to me until visiting our daughter, son in law, grandkids and my 86 year old mother.
Each day I walked out my mom’s front door (she has lived in the same house for 50 years) and enjoyed the view where I grew up.
Mt. Hood…Pancha Mama. Something was gnawing at me…where had she led me? I missed the connection.
The equivalent geometry at Mt, Cotacachi that I now see each day from my Cotacachi front door.
This did not hit me until we took mom to our favorite beach…our historical escape on Oregon’s coast. This shot as I looked down the beach made me think about this more.
Because the geometry is so like our beach escape in San Clemente, Ecuador.
July 24-26 IBEZ North Carolina
Oct. 9-11 IBEZ North Carolina
Oct. 21-24 Ecuador Import Export Expedition