In negotiations and business reviews companies and individuals often fight for the last percentage point of price, value or wage adjustments. Investors conduct elaborate analysis to review the value of companies. But, then, along come the gigantic shifts in the value of currencies. 

This begs the questions; Can we make any sense out of the recent movements of currency values, and what may be expected in the months to come?

I tried to answer these questions in a recent presentation, focusing on four currencies; the American dollar (USD), the Euro, the Norwegian Krona (NOK) and the Brazilian Real (BRL).

Exhibits 1 and 2 give some background. Exhibit 1 shows the relative importance of the world 

Exhibit. 1
Exhibit. 2

Currencies measured by their share or world GDP, including all that represents more than 1% of global GDP (plus Norway with 0,5%). Other measures may be equally relevant, e.g. share of trade, share of financial holdings, share of transactions or the share of currency reserves. The story is the largely the same;

Exhibit. 3

four currencies matter, the USD; Euro, the Japanese Yen and the Chinese Yuan. Sorry Brits. Exhibit 2 serves as a reminder. The value of each currency is relative. It is decided relative to the value of a basket of currencies. 

Hence, we need to look at the value of the baskets, especially of the four global currencies. This is shown in Exhibit 3. The chart shows, indexed, the number of Euros, Yens, Yuans and, yes, pounds, needed to buy one US dollar.

Four shifts stand out; firstly, the other currencies strengthened themselves relative to the USD up to 2008. US interest rates were taken down, and investors bought other currencies as they hunted returns. 

In 2008 all crashed, with the collapse of the US housing market, the investment bank Lehman Brothers and numerous other break-downs. But, paradoxically, the collapse that started in the US led money to seek a safe haven. 

In the US. 

This is the reference market and the most liquid market, where investment opportunities can be found. Fear beats greed in periods of instability. No interest difference can compensate for a fear of a significant drop in equity or currency values.

Then came a period of apparent stability, as most major Central banks kept interest rates down in their push for recovery. However, in 2014 the US initiated rate hikes. Now more foreign currencies were needed to buy a dollar. This summarizes the 20-year history of the value of the major currencies. 

Covid-19 has shocked the world, less so the relative value of the major global currencies. 

Turning to a broader set of currencies, the picture is supplemented. Here I include the NOK, the Swedish Krona (SEK), the BRL and a basket of commodity countries´ currencies (Australia, Canada and New Zealand).

Exhibit. 4
Exhibit. 5

The pattern is largely similar for the NOK and BRL up to 2013. Then the BRL is hit as Brazil enters recession and the political battles intensify. The NOK is hit as oil princes plunge in 2014. Thereafter the NOK stays weak, but otherwise follows its “commodity peers”. Brazil, however, clearly has its very own ups and downs.

Along came the covid-19, recession, the oil price collapse and (in Brazil) political turmoil. The pile of BRLs and NOKs needed to buy a dollar rose sky high. 

Now, one more piece of the puzzle must be added. Inflation. The nominal (“face value”) currency rates must be adjusted for inflation. More BRLs may be needed to buy one dollar. However, this matters less if all BRL prices and wages have been increased as years passed by.

Which is exactly what happened. Exhibit 4 shows the currency area inflation since 2010. The Brazilian inflation tops the list, while the Norwegian inflation slightly exceeds the US-inflation. The inflation focused European Central Bankers delivered the lowest inflation.

Adjusting the nominal rates with the inflation rates one gets the real rate of inflation. This is the metric economists tend to focus on, “the real exchange rate”. 

Post-adjustment the BRL-rate appears suspiciously similar as compared to the NOK. Both currencies have lost value since 2018, especially as covid-19 emerged.

Exhibit. 6

This goes hand in hand with a drop-in equity value. Many have commented on the surprisingly modest decline in US equity values. This may well be true, but (the dominant) US investors see a 25% drop in the USD value of Norwegian equities and a 50% drop in the USD value of Brazilian equity.

According to the book, investors should see straight through these combined effects in search for undervalued equity. But, not in the real world. Here a circular effect may occur. Equity markets fall as investors expect adverse market conditions. The currency follows. And thereafter, again, the equity values plummet. The fear of illiquidity contributes to the downward spiral.

Exhibit. 7

Next our journey brings us to the economic fundamentals. Where do we see green, yellow and red lights for the economies?

The next chart simplifies it all. 

Firstly, the differences are modest. Secondly, the US neither clearly beats Norway nor Brazil. As often seen, short-term currency movements aren´t always driven by fundamentals.

Exhibit. 8

One warning flag has though been raised for Norway. In short, the economy is clearly off-track. The businesses that earn foreign currency or substitute imports have for long been mistreated. The one thing that shouldn´t have happened has happened.

This concern was raised in February 2020 by the one person who influences the currency the most, The Norwegian Central Bank Governor. He presented the chart that follows.

Exhibit. 9

The chart shows a rapid increase of the Norwegian non-oil trade deficit. Simply put, Norwegian businesses aren´t in position to prosper. A lower rate and weaker currency is one mechanism to change the trajectory of the curve.

Furthermore, the shortage may also lead to a lack of foreign currency, as shown (simplified) in the next chart.

Exhibit. 10

The blue line shows foreign currency earned through non-oil exports. The red line shows what´s needed to finance our imports. A grey area remains, even when accounting for the government´s exploding oil money spend.

Yet another paradox emerges. The covid-19 rises the government spend level to astronomic heights. This closes the imbalance as the government taps the foreign currency of the oil fund.

Which really should make us concerned. Through the current wave of government spending it may appear that the challenges are solved here and now, but in reality, we may be experiencing a large shift in the wrong direction. Maybe that´s what the currency markets are seeing.

Among all global economies, Brazil is among the ones least exposed to trade. The imports and exports to GDP-ratios of Brazil are among the lowest in the world. Hence, as often seen, the development of the currency is often decoupled from fundamentals. Capital movements, especially initiated by the Brazilians themselves, steer. Consequently, the BRL-value moves off-track every now and then, based on the sentiment in São Paulo.

Where does this leave us regarding the NOK and BRL? 

The fundamentals support a significant reversion, especially in Brazil.  But, not all the way to prior levels, especially for Norway.

Harald sees that the value of his krone – crown – evaporates.