HardAssetsInvestor

Written by Brad Zigler  |

October 21, 2010

The Dollar Is A Third-Rate Currency

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How have worldwide currencies held up against gold over the past year? The answer might surprise you.

 

To many investors' surprise, the Yankee dollar's earned only a third-place ribbon for its depreciation against gold over the past 12 months.

With all the recent hoopla and headlines about gold making new highs against the greenback, the destruction derby of the world's reserve currencies is actually won by the euro, with sterling close behind.

Over the past year, the U.S. dollar lost 29.8 percent vs. bullion compared with a 39.7 percent tumble for the European common currency and a 34.5 percent decline in the British pound. Bringing up the rear is the Swiss franc, with a 23.1 percent loss, and the Japanese yen, which gave up 16.4 percent to gold.

 

Gold Value In Reserve Currencies

 

Oddly enough, the U.S. dollar's the least volatile reserve currency when it comes to bullion purchasing power. Its standard deviation is just 15.3 percent over the past year. This may not seem like a testament to the Fed's steady hand on the nation's economic tiller, but it's something. It actually bespeaks the wait-and-see attitude of the central bank after last year's stimulus and accommodation.

The likelihood of Fed intervention increases when commodity prices—a basic metric of inflation—rise or fall significantly compared with Treasury securities. In the chart below, the red Fed Indicator line dances within a neutral zone—a condition that compels the central bank to watch, but not act. A sustained move in the indicator above the upper band would signal an increased likelihood of accommodation—or lower money rates and a weaker dollar. A dip below the lower band flashes a higher probability of tightening, or higher rates and a stronger dollar.

 

Fed Operation Indicator

 

Keep in mind that this indicator is just that—an indicator. It measures the likelihood of Fed intervention, not its certainty. Political considerations—which can be substantial—are put aside here. We dealt with such notions in our feature "Inflation Vs. Deflation: An Internal Debate."

For now, the Fed's keeping a fairly even keel—even though it's been economically painful for employees or the unemployed. There's nascent inflation, reflected in the blue line's recent trajectory, which complicates the Fed's handling of the dollar. What's economically expedient may not be politically fruitful.

On the other side of The Pond, sterling's been the most volatile currency, flopping about with a 17.8 percent standard deviation. Largely, this reflects the rising and falling fortunes of the former Labour government. Just this week, the coalition government's declaration of austerity measures sent the pound into free fall vs. bullion.