The Theory of Relative Value

The dollar is falling again, fast. A new 13-year low against the Japanese yen and the fastest decline in comparative value with the Euro since the latter was first used in 1999. The Federal Reserve’s drop in the discount rate, while anticipated, definitely reduced the value of investors’ migration of currency into the U.S. But the never-ending litany of bad news – from the willingness of Americans to buy zero or negative interest Treasuries (a strong statement that even we believe this is an economy with a lot more dropping to do), the passing of the magic “billion dollar” benchmark in global bank losses (more than 2/3’s from U.S. banks!), the struggle with a solution for American automakers, the unreliability of the U.S. government in its oversight of the markets (with a big exclamation point from the Bernard Madoff scandal), and the readjustment upwards of expected unemployment – seems to push the currency markets in the most obvious direction. Analysts are keeping a close watch on holiday sales and the continuing plunge in American residential and now commercial real estate. The numbers are not good news.

But Europe has some upcoming moments as well – the wide schism between the haves and the have nots is straining the European Union’s own search for a common implementable solution. And there is no simply panacea that would apply to the divergence of required economic solutions. If U.S. starts showing some slowing in the aggregation of bad numbers and bad news, the international focus will shift to Europe and Asia. Japan has been down so long that they were not able to splurge in the financial over-gorging of low quality, high yield, financial instruments that plagued the U.S. and Europe. Conservative Japan’s sunken economy now looks like a total winner from the even deeper depths of a U.S.-triggered “managed depression.”

The currency markets are becoming increasingly like that lost soul of wandering American stock market – reacting to trends and the latest news. With no overriding major positive economic trends anywhere in the industrialized world, value indicating markets are very much reactive and searching for trends. When a trend acceleration starts, the common wisdom is that “somebody must know something I don’t” that feeds on itself, spiraling numbers up or down on the new belief system, unless or until the news shows that the original projections are not as bad (or as good) as “things back home.” Relative value meets relative pain.

For those looking for clear answers, the only clear answer is that there aren’t any. Until consumer confidence stabilizes, unemployment numbers stop rising and real estate markets solidify, we are going to see a vacillating evaluation as each market-maker tries to stay ahead of whatever trend will steer the markets next. What the world is seeking is leadership – and with a lame duck Congress and President, that cannot be the U.S. until the regime change is implemented – and the biggest test of the new Administration will be whether or not they can convince the financial world that there is a knowing and steady hand on the rudder. More than anything else, leadership will make the difference as to how long bottoming out will take and whether the rest of the world will rebuild its faith in a system that, at least for now, still has the greatest power to shape the global economic future.

I’m Peter Dekom, and I'm looking for a solid, refurbished crystal ball.