Monday, April 25, 2011

The Unbearable Lightness of the Dollar

(Click on the graph to magnify)

The graphs shows the dollar value of one euro since June 9 2010. I cherry-picked the initial date as the most recent bottom of the euro. The depreciation trend since then is quite impressive.

It poses some interesting macroeconomic questions. If it represents a movement towards the reduction of the American trade deficit, then we should see a rebalancing of the capital account too. It could happen through an even greater decrease in investment (probably not an interesting outcome) or an increase in saving. Where will the increased saving be coming from? If it isn't the government, then households will have to do it, otherwise investment will fall even further compared to what it is today.

Alternatively, if not matched by higher saving, this trend will have to stop at some point, or it will need to be matched by higher prices in dollar, in other words, inflation. Just extrapolating the trend (silly, I know, but this is just a baseline exercise) indicates a matching yearly inflation rate of around 23%.

It took decades for macroeconomists to see so much action in their field.

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