Saturday, July 23, 2011

How high can loons fly anyway? (Part I)

With the Canadian loonie hovering clearly above parity somewhere between Cdn. $ 1.05 to 1.06 per U.S. dollar, the time has arrived to wonder how much higher this loon can fly? This may prove to be a critical weekend for the Canadian versus U.S. dollar relation. Now that the fires of the European debt crises have cooled a bit, the currency question definitely should be on the mind of Canadian investors.

I have updated the foreign currency graph from an earlier posting: Who really pays for all the money that the U.S. is borrowing? In this post I concluded that it is the rest of the world, or better those countries that hold U.S. debt via banks, investors or foreign currency denominated bonds, that pay for a large portion of that debt through a gradual U.S. dollar devaluation that started as far back as 2001 (Fig 1). Remember the German banks and the Irish banks that bought repackaged U.S. subprime mortgages by the bucket full (Structured Investment Vehicles and CDOs) that soured in 2008-2009? The result was forced government intervention in particular by Ireland which subsequently went broke; they basically bailed out a lot of U.S. debt.

Figure 1 Change in U.S. versus the Canadian Dollar (CAD); Australian Dollar (AUD); Japanese Yen (JPY); Euro (EUR) and Chinese Yuan (CNY) over the last decade.

So Canadians who invested in U.S. bonds in 2000, saw their principal value reduced by nearly 33.8%; Australian bond holders took a 44% haircut; Europeans lost 35% and the Chinese 22%. No wonder, the Chinese wanted to keep their Yuan being pegged to the dollar. They are holders of close to U.S. $1.3 trillion debt and they saw the principal of that debt drop by nearly 20% or 260 billion dollars when expressed in Yuan. To top that off, the Yuan itself is currently losing 5% annually in purchasing power (inflation). Only 2008 – 2009 interrupted the trend of continuous U.S. dollar devaluation with a temporary ‘flight to quality’. The U.S. is a safe haven? You must be kidding

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