Saturday, December 8, 2007

Dollar Vs Euro - Why Warren Buffet will be wrong on this or I wish he is...

Every time dollar hits a new low, I remember a discussion I had with my cousin brother, who works for Saudi govt, back in the winter of 2005. I argued that dollar will appreciate against Euro in 2006 due to the rate hikes by US Fed and expanding US economy. Indian Rupee will also weaken due to India's increasing energy bills to support expanding economy and maturing foreign investments in Indian stock market. In fact, both Euro and Rupee gained against dollar in most of 2006 (Dollar gained against rupee in the first half of 2006 but then started shedding value in the second half) . 2007 saw a steady erosion of Dollar against Rupee and most other currencies. So in the nutshell, if my cousin converted his US dollar pegged assets (Saudi Riyal is pegged to USD) into Euro in early 2006, he could have averted a 20% slide in value. If he had migrated to Euro in early 2003, he could have avoided a 30% slide. So clearly I was wrong and I feel partially guilty of directing him in a wrong direction.

Part of the reason for my lack of love for Euro was personal. We were in Europe for two weeks just before Europe adopted a single currency system. We were very excited to go to Europe and see first hand the mystery of Europe. The old port town and diamond capital of the world Antwerp, European Union's capital Brussels, The fun capital of the Europe Amsterdam and then of course the sophisticated Paris. We liked what we saw. High speed cross country train ride. Went to Louvre and saw Davinci Code! Had crape on the streets. Struggled to communicate to the French. Enjoyed the hospitality of the Brussels Business men at a very large brewery. Took a peek at the wax and sex museum in Amsterdam not to mention the lovely canal rides. Small cars and narrow cobble stone streets. Notre-Dame cathedral and Historic buildings. War memorials. Overall, a sense and sensibility of history guiding even a stroll to McDonalds. BTW, we were so homesick of US and ate McDonalds and Soda in Paris skipping famed Pinot Noir and breads!

Credit card rip off by a taxi driver in Antwerp who put an extra zero in the credit card slip, a scam artist at a Paris central station who buys non French speaking tourists one way train ticket saying that it is for a week unlimited travel, glass of water is billed the same as glass of soda, no free soda refill at restaurants, sleeping on small crammed beds, paying extra for having my wife as a guest in the room and paying lot more for everything else made us miss US so badly. It also taught us never to forget the boring common sense travel tips from grandma even if you are in Europe!

Putting it all together, we realized that Europe is no US in many good ways and many not so good ways. Just months before the Europe trip, we had a marathon tour in the US where we drove from Baltimore to DC to New York to Niagara. Got a free SUV upgrade from the rental counter (this is when the gasoline cost was $1.50 per gallon) from a compact car, Slept in oversize Eastern King beds, had free refills of extra large soda everywhere, almost always we could split a single meal into two, paid less than $50 per night at Sheraton through internet deal, over all we had a super sized experience. But the most historic places are not quite historic by European standards. Most historic down towns in US are as old or as recent, as a foreign tourist will say, as Route 66.

That is when the realization started sinking in. Europe represents the past and US the present and possibly the future. Europe is expensive and exclusive while US is efficient and inclusive. While America does not have the burden of history pulling it down, she also has no frame of reference about building great things. So she builds THE greatest! The greatest gold rush, greatest sub division madness in the west, greatest trading markets, greatest banks and investment companies, greatest technology companies, greatest movie industry, greatest universities and greatest junk food companies. On the flip side, even when they make blunders, that assume great proportions. Greatest market meltdowns, Greatest military blunders in Vietnam and now in Iraq, greatest corporate scandals, greatest automobile disaster brewing in Detroit, greatest sub prime credit crisis in modern day economics, greatest trade deficit by any country, the list goes on. When US makes a mistake, the world punish her very harshly. The Dollar hating going on in the world right now is no exception. It is a statement and warning by the world that they want US to make amends. Not an outright rejection, but because the world has higher standards for US.

It is no secret that us trade deficit with other countries would have an impact on the dollar value in the long run. The oracle of the US, Warren Buffet warned in 2003 of dire consequences if US did not act on reducing trade deficits in a war footing basis. (See the link below). But what is surprising is that Europe is not growing any faster than US and Europenas are not working any harder but still people have a new found love with euro. It is mostly sentimental and euro in the long run will not stand up to $. Not until the French unions stop acting like trade unions in Kerala (An India State where you pay workers to unload tiles for your kitchen or you pay them and do it your self if you are DoItYourself type). Europe's iconic Airbus engineers drew the wiring for A380 in 2-D and fell much short when they tried to wire the 3-D space. Engineering Drawing 101! (Read my previous post on Airbus A380's wiring problem)

Once the envy of the world, German cars are loosing market share to Lexus and Infinity. So from no angle, I see a resurgent Europe except in exchange rate graph. Euro is the new fashion statement to people who does not like US and Bush. But it will fade as new president takes charge in early 2009 and by that time US would have wiped out a lot of trade deficit simply by allowing dollar to sink. In fact that is a calculated move by the US to increase US exports and decrease imports and there by balancing decade long deficit spending. So this trend will continue for some more time until foreigners with excess forex like Chinese, Indians, Arabs and find US assets too cheap to resist and start buying them in bulk. Dubai poured in billions into Citi bank. Even Mahindra is buying a us auto plant. Believe it or not, I found a MADE IN USA TOY at target. Finally, manufacturing is making a come back to the US. US has the most advanced market in the world and as long as foreigners have a liking for us assets and properties, dollar will not melt down as many fear now. But another 20-25% slide in dollar will not be a surprise in the next couple of years. But that is my assessment and you know how I was wrong in the past and have no credentials on this subject :)

Dollar to rupee relation is much more complicated. If India continues to grow at the current rate (which might be difficult considering the impact of rising oil prices on india's growth) rupee has to appreciate to reflect the new wealth. But the reality is that rupee has gained unusual momentum in the last 6 months due to hedge fund and pension fund managers from the us pouring billions into Indian market riding BSE on steroids. With sub prime securities no longer an investment option, us investors are flocking into emerging market. The hedge funds are like herds. They go together and come back together. So there will be a coming back home time for all the us $ some time in the next two years and rupee will slide back to 45-47 range. Having said that, rupee will be around 25-30 in next 25 years because of the huge growth potential india has over US in the long run.

So brace for a stock market crash in India some time in 08-09 as the hedgies pull out with a huge sucking sound. It will give a temporary window of opportunity to transfer some $ denominated instruments to rupees similar to an opportunity when BJP govt fell and left backed govt came to power.

Long post. Let me stop by repeating the cliche, dont put all the eggs in one basket. You will never loose if you diversify. Have assets in many instruments. Some stocks, some forex, some dollar, some euro, some real estate, some cash, some gold. Even an emergency preparedness kit is million dollar worth when it matters the most.

Pardon my foolish audacity to write about something I can claim no authority. But one thing I can say with conviction is that a country which can produce Warren Buffet and Bill gates will not be an easy push over for centuries to come.

Warren Buffet's prediction: Growing Trade Deficit and Dollar Decline 2003 article


Anonymous said...

Interesting thoughts for the future of the US economy.

Jeff Caliva

God Blez jUSA said...

I wonder if we have a new president and he is friendly to Europe, can we make the dollar back to 1:1 against the Euro. I think that's how it should be anyways. Europe/America are very nice places, so their money should be the same value? Am I wrong?