The Big LoserThe Daily Reckoning
London, England
Wednesday, February 09, 2005
The Daily Reckoning PRESENTS: In 2004, the U.S. dollar appreciated by 85% against the Zimbabwean Dollar. It was an anomaly...virtually every other world currency got stronger. Which was the best performing currency in 2004? Here's a breakdown...THE BIG LOSER
by Marc Faber
At this year's Barron's roundtable panel discussion, I mentioned the following example from Swiss real estate in order to make a point about the diminishing purchasing power of money...
A house in the prestigious Suvretta area of St. Moritz, which had changed hands in the early 1970s for less than 1 million Swiss Francs, had recently fetched 25 million Swiss Francs. Immediately, one of the smarter participants in the discussion took out a calculator and, after doing some math, informed me that this amounted to a compound annual rate of return of "only 7%".
Besides the fact that a 7% compound annual return on any asset is a very high return (or rate of inflation for that particular asset), my fellow participant also overlooked the fact that this 7% annual return was in Swiss Francs and not in U.S. dollars.
Since the Swiss Franc has more than doubled against the U.S. dollar since the early 1970s, in dollar terms the rate of inflation of the value of the property would obviously have been much higher.
Moreover, the return would also have been boosted had the owner let out his property instead of using it for himself. But these are minor points. The significant point that I wished to make was that, for exactly the same house, one would have to pay today more than 25 times what the property would have sold for in the 1970s.
To anyone with any common sense, this indicates a serious loss of purchasing power of money.
A year ago, I explained that 2003 had been an unusual year in the sense that all asset classes — including bonds, equities, commodities, real estate, and art — had risen in value, and that 2004 would see the emergence of some diverging trends among these various classes.
Well, I was wrong! In 2004, all asset classes continued to increase in value — with the exception of the U.S. dollar, which depreciated further against stronger major currencies such as the Euro, the Swiss Franc, and the Yen.
The U.S. dollar lost even more in value against some of the more exotic currencies, such as the Polish Zloty (+23.9%) and the South African Rand (+18.1%).
For the record, in 2004, the other best-performing currencies against the U.S. dollar were: Colombian Peso (+18.1%), Hungarian Florint (+15.7%), Iceland's Krona (+15.6%), South Korean Won (+15.6%), Czech Koruna (+14.9%), Slovakian Koruna (+14.8%), and Romanian Leu (+11.3%), while the Swiss Franc appreciated by 9.10% and the Euro by 8.02%.
In 2004, U.S. dollar holders may, however, have found solace in the fact that against the Zimbabwean dollar, the Greenback appreciated by 85%, and is up by 99% since 2000.
I have mentioned these currency movements for several reasons. For one, in Euro terms the Dow Jones declined last year by 4.5% and the S&P 500 was up by just 0.9%. (By comparison, German bunds were up by 10% in Euros and 19% in U.S. dollar terms.) So, when pundits forecast an S&P 500 level of 1,350 or higher by the end of 2005, they should also specify at which level of exchange rates the U.S. dollar will find itself. After all, in an inflationary environment (asset inflation), domestic prices can be boosted by an expansionary monetary policy, but at the corresponding expense of a weakening exchange rate.
Alternatively, U.S. monetary conditions could tighten and reduce or eliminate the rampant asset inflation, at the same time boosting the value of the dollar.
For now, it is important to realize that the strong appreciation of the Euro and other European currencies over the last two and a half years has led to a very significant overvaluation of the Euro against the Asian currencies, which, since the beginning of 2000, with the exception of the Korean Won (up since then by 8%), have hardly moved against the U.S. dollar.
So, whereas since January 2000 the Swiss Franc, the Euro, and the Pound Sterling have risen by 35%, 29%, and 14%, respectively, against the U.S. dollar, over the same period the Japanese Yen is up by just 3% and the Singapore dollar by 2.5%, and the Taiwan dollar is down by 3%. The Euro has performed strongly against the Japanese Yen and the Singapore dollar, which has led to a relatively low valuation of Asian assets expressed in Euro terms despite their appreciation in U.S. dollar terms. The Singapore stock market has almost recovered in U.S. dollar terms to its year-end 1999 level, whereas in Euro terms it is still significantly below that level.
I mentioned above that in both 2003 and 2004 all asset classes rose in value. Therefore, when I look around the world I find very few bargains among bonds, equities, properties, and industrial commodities. Yet, largely due to currency movements, relative values seem to exist in Asia where asset values (equities and real estate) appear to be inexpensive compared to the rest of the world. So, stock market bulls are once again advised to increase their weightings in Asia, including Japan, where it is common in most countries for dividend yields on individual stocks to exceed domestic bond yields.
However, since all asset prices have risen strongly over the last two years, two possibilities should be considered. In the long term it is, of course, inconceivable that commodities, real estate, and bond prices will all rally at
the same time. Rising commodity and real estate prices do lead, at some point, to inflation in consumer prices and so to more obvious inflation (for economic luminaries — such as Fed members — who define inflation only as an increase in the Consumer Price Index).
Rising interest rates follow, which then depress bond prices. Therefore, what I expected to occur in 2004 — namely, the emergence of some diverging trends — is likely to shape the financial landscape in 2005. If U.S. monetary policies were to remain loose, a further weakening of the U.S. dollar, rising CPI inflation, and rising long-term interest rates would almost certainly follow.
The question in this expansionary monetary policy scenario is to what extent asset prices could continue to appreciate if inflation and a weak dollar were to drive 10-year U.S. Treasuries' interest rates to between 5% and 6%? In a society addicted to debt, and where asset prices have been badly inflated, even a small increase in interest rates could have serious implications for all asset prices!
Regards
Marc Faber
for The Daily Reckoning