Monday, June 7, 2010
With gold today hitting a new all-time against the dollar, and the world fixated on how the euro is "plummeting," I thought a bit of perspective was in order. As this chart shows, the euro (as the extension to the DM) and the dollar have been moving pretty closely together relative to gold. That is to say, both have depreciated by almost the same amount since 1978, with the dollar for the most part leading the way. You might say that the euro's current weakness is more in the nature of "catch-up" to the dollar than anything else. Recently, the euro was trading at a nice premium to the dollar, but that premium is no longer justifiable given eurozone credit concerns and the bailout of Greece.
As the second chart shows, the euro—relative to its purchasing power parity vis a vis the dollar—has not changed much at all since 1978. It was slightly overvalued then as it is now. In other words, relative to 1978, one euro today will buy you about the same basket of goods and services in Europe as it would in the U.S. So the message of these charts is that both the euro and the dollar have fallen by more or less the same amount relative to gold. The yen is the only currency that is worth more today, in terms of gold, than it was in 1980.
Regardless, the movements of major currencies relative to each other is now dwarfed by the movement of all currencies relative to gold. Put another way, the biggest thing happening today in the currency markets is the collapse of all currencies relative to gold (or should I say the rise of gold against all currencies?). If gold is still the timeless standard against which to measure currencies as it has been for centuries, then today it can be said that the relative valuation of one major currency relative to another is an order of magnitude less important than the relative valuation of all currencies relative to gold.
If all major currencies are losing value relative to gold, that is a good sign that the world's supply of money exceeds the demand for it, and that is a necessary precursor to rising inflation. We should expect to see inflation rising in just about every country, and it ought to show up first in lesser-developed countries, since their economies are generally more exposed to international trade and have a lot less inflation "inertia" than the U.S. economy.
I continue to believe that it makes a lot more sense to worry about inflation than it does to worry about deflation, given the significant rise in gold over the past 10 years.
Posted by Scott Grannis at 11:23 AM