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The Big Question

Q: Is That a Euro in Your Pocket?
A: "The euro has been in a major cyclical upswing. In terms of value, it's the big kahuna now. Since the end of 2001, the dollar is down relative to the euro by around 43 percent. But I don't think the public's grasp of the implications is very firm. Most commodities traded internationally are priced and invoiced in dollars. Therefore, if the dollar is weak, you have to pay more dollars to buy a bushel of corn. At the end of 2001, the price of corn was $2.09 a bushel. On June 30 of this year, it was $7.25. And 61 percent of the price increase is accounted for simply because of the dollar's decline against the euro. Food price increases are, in large part, a weak-dollar story.

"People are talking a lot about the price of oil. But they fail to realize that half of the run-up in oil price is the result of the weak dollar. At the start of 2002, oil was trading at about $20 a barrel and today's price is around $125 a barrel. The dollar's decline against the euro has accounted for almost $54 of that price increase. This is huge.

"As an applied economist and trader, I build alternative scenarios that might affect exchange-rate movements. I then assign probabilities to each scenario. Today, any trades involving the dollar are very risky. There are plausible scenarios suggesting the greenback will bounce back from its cyclical lows. There are also plausible scenarios suggesting a collapse — particularly since we will have a new president next year, and in economics and finance, both candidates are as light, or lighter, than our current lightweight commander-in-chief.

"The current risks associated with anticipating the future of the greenback explain why I have not traded the dollar for some time and instead have focused on cross-trades that involve buying the Australian dollar and simultaneously selling the New Zealand and Canadian currencies."

Steve H. Hanke is professor of applied economics in the Whiting School of Engineering, co-director of the Institute for Applied Economics and the Study of Business Enterprise at Johns Hopkins, a senior fellow at the Cato Institute, and a columnist for Forbes magagazine.
— Interview by Dale Keiger

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