Is It Finally Time to Hedge Your Currency?

Loonie vs greenback vs Euro.

June 1, 2010

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967714_lost coinA few weeks ago, some Canadian consumers were celebrating dollar parity. The Trojan debt that Greece presented to Europe — more particularly, the German banks — put an end to that. The loonie is at 93 cents and the Euro has dropped  18.5% over the past six months. Now all bets are on the U.S. Should they be?

Menzie Chinn, professor of Public Affairs and Economics at the University of Wisconsin, Madison partner with James Hamilton at Econbrowser, offers reasons to think the Euro is on a downward path. What does that mean for the U.S.?

“The Euro has been depreciating against the dollar over the past few weeks. The implications of this development for the US depend critically on (1) the extent of the depreciation, (2) the duration, and (3) the source of the depreciation.

“…the first flight-to-safety induced dollar appreciation faded after about a year. This second dollar appreciation might be construed as another flight-to-safety. How lasting will this appreciation be? Much depends upon how and whether the Euro area governments resolve the current crisis. It also depends upon the desirability of US dollar denominated assets, including Federal government debt.

“Since I am less pessimistic than some others regarding the short to medium term deficit outlook for the US I think that the upward appreciation of the dollar against the Euro might be fairly persistent.”

Chinn also reports on an OECD study on the impact of the declining Euro on U.S. GDP — a relatively modest contraction as Euro-goods become cheaper. Interestingly, there is a much stronger and  positive effect — a multiplier effect — from U.S. government spending.

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