What's Going on with Currencies These Days?

An Introductory Primer to Foreign Exchange Markets - Article #54

May 01, 2024

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In this 14-minute article, The X Project will answer these questions:

I. Why this article now?
II. What is the U.S. Dollar Index?
III. What does it tell us?
IV. What is the dollar doing against the Euro?
V. How is the dollar doing against our largest trading partners?
VI. How is the dollar doing against the currency of the second largest economy?
VII. How about against the Japanese yen?
VIII. And the Indian rupee?
IX. What does The X Project Guy have to say?
X. Why should you care?

Reminder for readers and listeners: nothing The X Project writes or says should be considered investment advice or recommendations to buy or sell securities or investment products. Everything written and said is for informational purposes only, and you should do your own research and due diligence. It would be best to discuss with an investment advisor before making any investments or changes to your investments based on any information provided by The X Project.

I. Why this article now?

“Money” is one of The X Project's ten topics of interest, but I have not written too much specifically about it. I have written a little about the U.S. Dollar in the following articles:

However, I have written a lot about inflation, including the following articles and all of the articles above (except “Money and Empire”:

Many more articles conclude that inflation is a big problem for the foreseeable future, and it is a problem because it reduces the purchasing power of our currency, the U.S. Dollar. However, I am writing this article now as there are some interesting things happening in the Foreign Exchange (Forex) markets that have implications on the dollar and inflation, and there are some interesting debates about what will happen in the future. So this article will set some background context and point out some interesting things so a future article can delve into some of the debates about the future.

II. What is the U.S. Dollar Index?

The U.S. Dollar Index, also known as the USDX, DXY, DX, or “Dixie,” was created in 1973 by the U.S. Federal Reserve after the U.S. abandoned the gold standard and dissolved the Bretton Woods Agreement. It is maintained by ICE Data Indices, a subsidiary of the Intercontinental Exchange (ICE). The index started with a base of 100 and measures the dollar's relative value against a basket of currencies. The original basket included the German mark, French franc, Italian lira, Dutch guilder, and Belgian franc - all of which were replaced by the Euro in 1999 - plus the Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona.

Here are the weights of the six currencies today:

Euro (EUR) = 57.6%
Japanese yen (JPY) = 13.6%
British pound (GBP) = 11.9%
Canadian Dollar (CAD) = 9.1%
Swedish Krona (SEK) = 4.2%
Swiss Franc (CHF) = 3.6%

Here is a chart of the DXY going back to the beginning:

III. What does it tell us?

Well, it does not tell us very much except how the dollar compares to that very specific basket of six other currencies weighted in proportions that have little bearing on reality.

Here are the top fifteen economies in the world ranked by GDP based on IMF data as of April 10, 2024:

Only four Euro countries make the top fifteen: Germany, France, Italy, and Spain. Their combined GDP is $11,877 billion. According to the World Bank, the total Eurozone GDP in 2022 was $14.21 trillion, which puts it in third place in the rankings.

Here are the top fifteen trading partners in goods for February 2024 according to the U.S. Census Bureau:

This is monthly data, and I couldn’t easily find annual data. I did spot-check another month, June 2023, and the top seven partners were the same, with their percent of total trade within a couple of tenths of a percent of February’s data. As for the bottom eight, the order was a little different; Brazil made the list in June at fifteen, while Singapore did not.

My point is the basket that comprises the dollar index neither looks like the world economy or world trade within it. Surprisingly, many analysts and commentators focus on the dollar index notwithstanding. It is more insightful to look at individual currencies against the dollar.

IV. What is the dollar doing against the Euro?

Let’s look at the Euro first since it comprises over half of the dollar index. Here is a chart of the EUR vs. the dollar:

The Euro’s all-time low against the dollar, at least synthetically speaking since technically it did not exist yet, was $0.54 in May 1971. The next low was $0.56 in February 1985—before the Euro existed. The Euro was launched on January 1, 1999, as an “invisible” currency used for accounting purposes and electronic payments, and the physical euro currency was introduced on January 1, 2002. The next significant low was soon after launch in October 2000 at $0.82.

The Euro’s all-time high against the dollar was $1.60 in April and July 2008. Since then, it has generally been trending downward, with ups and downs of greater than 20% at times, and today, it is at $1.07.

Let’s next look at our largest trading partners and how the dollar is doing against their currencies.

V. How is the dollar doing against our largest trading partners?

As we saw in Section III above, Mexico is our largest trading partner, and here is a chart of the dollar vs. the Mexican peso:

Unlike the Euro chart, which showed Euros priced in dollars, this chart shows dollars priced in Mexican pesos. Therefore, up or higher on the chart, the peso is getting weaker against the dollar, and down or lower on the chart, the peso is getting stronger.

The chart shows that the peso was tightly managed until December 1994, when it started to float freely due to the “Mexican Peso Crisis.” In November 1994, a dollar cost 3.43 pesos. It generally weakened over the next 26 years until it crashed to an all-time low in the early days of the pandemic shutdown, when it took 25.78 pesos to buy a dollar in April 2020.

Since then, however, the peso has been strengthening and is back to 17 pesos for a dollar, the strongest it has been in eight years.

Canada is our next largest trading partner, and here is a chart of the Canadian dollar:

This chart is shown like the peso, with the U.S. Dollar in the numerator and the Canadian dollar in the denominator, and so up is weaker for the Canadian dollar, and down is stronger. When the U.S. Dollar first broke free from the gold standard, it was basically on par with the Canadian dollar. Over the next three decades, the Canadian dollar generally weakened against the U.S. dollar, hitting an all-time low of 1.62 Canadian dollars for one U.S. Dollar in January 2002. From there, it strengthened relatively quickly, hitting an all-time high of 0.906 Canadian dollars for one U.S. Dollar in November 2007 and a second high price of 0.94 Canadian for one U.S. Dollar in July 2011. Then, the Canadian dollar weakened to a low of 1.47 in January 2016, which it hit again in March 2020 - marking the recent low end of the range, with the high end at 1.20 hit in September 2017 and May-June 2021. It is at 1.37 today and trending sideways in a historically generally weak range.

VI. How is the dollar doing against the currency of the second-largest economy?

The second-largest economy in the world is China, but what is their currency? The Renminbi? Or the yuan? Both terms are generally interchangeable, but the currency's official name is Renminbi, which literally means “the people’s currency” in Mandarin. The Yuan is the everyday term used to describe the currency and is the unit of account for the Renminbi. The largest banknote is 100 yuan, followed by 50 yuan, 20 yuan, 10 yuan, 5 yuan, and 1 yuan.

Here is a chart of the U.S. Dollar priced in yuan:

You can immediately see some differences in this chart from the other charts. First, the Chinese yuan was not available for Forex trading prior to 1981. Second, the Chinese government tightly controls the currency—sometimes maintaining a peg to the U.S. Dollar and other times, including currently, allowing it to float within a range set by the government. Third, there is a big gap in the chart when, in January 1994, the Chinese government devalued the yuan by 45%. A few months later, in August 1994, the yuan hit its all-time low against the dollar at 8.64 yuan. Since then, the strongest it has been is January 2014, when it was 6.04 yuan to the dollar. Today, it is 7.24 yuan.

Given that China is the second-largest economy in the world and given the geopolitical great power competition (or World War III) that is underway, the direction of the yuan is highly significant. There is a debate within macroeconomic and geopolitical circles about whether it will strengthen or weaken, with solid arguments on both sides. However, this will be a topic for another article soon.

VII. How about against the Japanese yen?

Here is a chart of the U.S. Dollar vs. the Japanese yen:

When the U.S. Dollar was on the gold standard, it cost 357.5 yen. As soon as the dollar went off the gold standard, the yen strengthened by nearly two-thirds to 120.3 yen by January 1988, with the majority of those moves happening in three sharp waves that can be clearly seen on the chart. The all-time high was reached in October 2011 at 75.57 yen for one U.S. Dollar. Since then, the yen has generally been getting weaker and has been doing so in earnest since January 2021. It is now back down to 157.5 yen, which is the lowest it has been since May 1990.

This is highly relevant since the yen has been heavily used by investors, traders, and speculators in what is known as the yen carry trade. The short-term interest rate in Japan has been below 0.5% since November 1995 and has spent most of that time at 0% or negative 0.1%. The carry trade is when the yen is borrowed at low to non-existent interest rates and converted into another currency—usually U.S. Dollars. In March 2024, the Bank of Japan (BoJ) raised short-term interest rates from negative 0.1% to positive 0.1% - the first rate hike in 17 years, ending the era of negative interest rates. Both the level of the currency and interest rates bear watching closely since an unwind of the yen carry trade would majorly impact the financial markets and thus will likely be covered in another article before long.

In the next section, we will look at the Indian rupee, the currency of the fifth-largest economy in the world and one of the fastest-growing. In Section IX, I will tell you what I think about all this. And then in Section X, why you should care and, more importantly, what more you can do about it. However, I have just hit a new paid subscriber threshold, so you must now be a paid subscriber to view the last three sections. The X Project’s articles always have ten sections. Soon, after a few more articles, the paywall will move up again within the article so that only paid subscribers will see the last four sections, or rather, free subscribers will only see the first six sections. I will be moving the paywall up every few weeks, so ultimately, free subscribers will only see the first four or five sections of each article. Please consider a paid subscription.

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