July 08, 2024
Non-Farm Payrolls were reported last Friday and despite slightly higher than expected numbers for June, the overall publication suggests that the US labour market is cooling off. The 206k new jobs surpassed consensus of just 190k, but the small excess was dwarfed by revisions to the April and May figures. Publications for the previous two months were revised down by a combined 111k jobs – a correction not uncommon for NFP data releases. The unemployment rate on the other hand ticked up to 4.1%, from just 4% previously.
The NFP data leans into the narrative that the Fed is approaching an economic situation that would allow it to lower interest rates. Many analysts were saying the same thing six months ago however, so any optimism surrounding monetary easing should be taken with a pip of salt. US indices took the news well, with the Nasdaq Composite in particular gaining 0.9% on Friday to achieve yet another record close. Gold ended the week on a positive note, gaining 1.5% on Friday to close at $2,391 an ounce. The DXY took a predictable hit, losing roughly a quarter of a percent on the day.
Currencies in general have been relatively muted recently, especially given that both the UK and France have just held elections. There may be more volatility in the Euro later today as markets digest yesterday’s results from France’s second round election. On the other hand, markets will have to contend with drama in the cryptocurrency sphere, with news that the Mt. Gox bankruptcy trustee has begun to repay bitcoin to creditors, a decade after the infamous hack occurred.
The economic calendar is looking particularly sparse early this week, with a couple of appearances from Fed Chair Jerome Powell tomorrow and Wednesday possibly breaking the mould. On Thursday, US CPI data will offer further insight into the world’s largest economy, but other than that, markets will not have much to get excited about this week.
Happy Easter. Gold takes the spotlight once again as much of the world takes a break from markets during this Monday holiday. Prices are already up over one percent at the time of writing, pushed as high as $2,260 an ounce during the Asian morning session. Given the effects of time differences and market closures in the western hemisphere, one can only conclude that Asia is the main driver behind the recent surge in bullion prices. The People’s Bank of China was the largest buyer of gold last year amongst all other central banks but demand also remained high with private investors, many of whom are seeking safe-haven assets in light of the precarious situation in the Chinese property market.
Some promising data out of China yesterday in the form of the country’s National Bureau of Statistics PMI numbers. The manufacturing PMI in particular made for pleasant reading, coming in at 50.8 as opposed to the predicted 49.9, meaning the sector is officially in expansion as opposed to contraction. The figures were backed up this morning by the release of the Caixin manufacturing numbers, also coming in above expectations at 51.1, further confirming an expanding manufacturing sector.
Looking forward to the week ahead, we start the week with a slew of European PMI data, followed by Eurozone CPI and inflation data on Wednesday. Further down the line, we have US Jobless claims on Thursday before finally ending the week with Non-Farm Payrolls on Friday. A reminder that markets in China will be closed at the end of this week to observe Tomb Sweeping festivities.
For many, the term “financial centre” usually conjures up a very specific selection of cities: London, New York, Singapore, Shanghai, Tokyo, etc. But how did these cities come to occupy such a place? How long have they held such a mantle? In this article, we will look into how these cities rose to prominence.
We have to go back to the Middle Ages, to the city-states of Northern Italy, before we get to something resembling modern banking. Venice was ideally situated to act as a hub for Mediterranean trade. Due to its close relations with the Byzantine Empire, it was able to trade wine, grain, salt from Southern Europe in exchange for silks and spices from Constantinople. Not only that, but they were able to do so while paying little or no customs in the process. Unsurprisingly, this would generate an enormous amount of wealth for the city-state and would carry on for centuries.
Thanks to the grain trade, many novel banking tools were developed. For example, farmers could take out a loan from a bank and use the money to sow their fields. Later on, the harvest would act as repayment for the loan. In this way, the bank essentially had future rights to the grain. The bank would then go on to collect payments for the as-of-yet unharvested grain from foreign trading ports, a template for futures contracts widely used in finance to this day. Insurance would also become ubiquitous around this time, ensuring the grain trade could persist despite the ever-present threats of floods, drought, pestilence and war. Happy days.
In the 15th century, the Byzantine Empire was forced out of Constantinople and the Ottoman Empire took its place. This would mark the start of the declining influence of Venice and surrounding areas. Trade with the East became more difficult during this time, but luckily the Gibraltar Strait would open up and with it, access to Northern European ports. The financial centre of Europe would gradually shift to the Flanders and Netherlands regions, which had even greater reach. Ports in the Low Countries had access to the Americas, West Africa, Japan and all other major trading hubs of the time.
Besides geographical reach, the Netherlands’ other strong advantage was that of financial innovation. These innovations resulted from the difficulty of international trade at the time. Trade voyages to the other side of the world were extremely expensive and wrought with peril. Building, supplying and staffing a ship was a barrier to entry only the deepest pockets could overcome. To mitigate the risk, the Dutch had a pretty neat solution. Instead of a single entity financing the whole voyage, the endeavour was divided into shares. Companies and investment firms could purchase these shares and in doing so, possess a partial stake in the enterprise. In the event of a successful journey, profits were shared equally. In the event of failure, losses were not bankrupting. This is how the joint-stock company came into being and with it, the template for modern stock markets.
Eventually the various mercantile players would consolidate to form the Dutch East India Company in 1602, the size and scope of which would make the likes of Apple or Google look like a local corner shop today. Imagine a company with its own globe-spanning navy. Across the channel, in London, a similar venture had already begun a couple of years prior. Although the British and Dutch East India Companies would start around the same time, the latter was much better established and well-funded than the former. We’ll spare the reader too much of a history lesson but eventually the British counterpart won out and became the dominant player. Combined with the global balance of power shifting towards Britain, France, and to a lesser extent the Americas, Dutch influence over world trade slowly dwindled and by the early 1800s, London was the world’s de facto financial centre.
The banking practices that were first developed in Amsterdam spread to London where they were further refined. It was during this time that international finance began in earnest, with English contract law becoming the standard for financial agreements throughout the world. It remains the largest financial centre for numerous markets to this day, including derivative markets, forex markets, international bank lending, international insurance and the trading of base metals.
As the century progressed, the world became increasingly interconnected and multipolar. The first transatlantic cable was laid between London and New York in 1866; communication networks improved dramatically with the advent of the telephone; railways connected the far corners of the world. Free trade and capital flows were greatly facilitated, making international investments more feasible than at any other time in history.
By the 1870s, the world financial system was in the firm grip of globalisation. This had the inevitable effect of drawing power away from the traditional centres of London and Paris, spreading to New York, Berlin and a number of European cities. The First and Second World Wars would diminish Europe’s influence over international finance in favour of the United States. To this day, New York remains the home of the two biggest stock exchanges in the world, the three major global credit rating agencies, a vast number of hedge funds and investment banks, as well as the largest financial centre for public and private equities.
The end of the Second World War marked the start of the Japanese economic miracle that would culminate in Tokyo becoming a world financial centre in the 1980s. This waxing influence would then go on to spread throughout the Far East. Singapore and Hong Kong, ideally situated to capitalise on the explosive economic growth in Asia would quickly attain the same status. The rise of the Chinese economy would in turn rapidly establish Shanghai as its representative on the world financial stage. Even more recently, we have seen markets shift yet again, this time towards Central and Southern Asia, as well as the Middle East, in the financial centres of Astana, Mumbai and Dubai.
The growing number and geographic spread of financial centres may offer a reflection of the increasingly multipolar world we live in. When Venice established itself as the financial hub of the Mediterranean, it remained as such for the better part of a thousand years. Some things change; some things don’t. Financial centres may have shuffled around over the years. As for the activities they are renowned for? Not so much. At the end of the day, we buy and sell things to one another in much the same way as we always have. Even some of the more complicated financial instruments are in fact far older than one might expect. Perhaps the crypto revolution can shake things up a bit.
The Dollar Currency Index serves as a crucial metric for establishing the relative strength of the US Dollar within a wider macroeconomic landscape. The DXY, or Dixie as it is sometimes referred to, offers instant insight on the performance of the Dollar compared to other currencies. Let us take a closer look at it.
BRETTON WOODS
As with many things, the World Wars were the spark that set things in motion. After the First World War, Europe lay in ruins; it was time to rebuild. The Treaty of Versailles, written by the victorious parties, essentially passed the entire bill of the conflict to Germany, inevitably bankrupting them. This was a major contributing factor to the advent of the Second World War, which would lead to similarly destructive consequences in Europe and further afield.
Determined not to repeat the “beggar thy neighbour” policies of the past, economists and leaders from around the world set out to establish an international monetary framework as the basis for reconstruction. During the closing stages of the war, delegates gathered at Bretton Woods, New Hampshire, to establish how the new financial system would function:
- Firstly, the US Dollar would be fixed to $35 per troy ounce of gold
- Secondly, each member country of the agreement would guarantee convertibility of their own money to the Dollar according to pre-established currency pegs.
The above would result in the USD becoming the de facto world reserve currency. As an addendum, the conference also resulted in the creation of the International Monetary Fund (IMF) as well as other entities that would go on to form the World Bank.
Over the next few decades, the system worked incredibly well. Perhaps a little too well. Due to its convertibility to gold, the Dollar became very attractive, both domestically and internationally. To keep pace with increased demand, more Dollars were printed. So much so that by the 1970s, there were four times more Dollars in circulation than could be backed up by the gold reserves of the time. This meant that the Dollar was extremely overvalued, which was a problem in its own right, but led to the other issue of huge gold outflows out of the US.
By the time Richard Nixon took office, the situation was untenable. The system that was arguably responsible for post-war economic stability and growth had to go. The Bretton Woods system was abandoned and the Dollar taken off the gold standard. This created a problem: by severing the tether between the Dollar and gold, suddenly there was nothing to properly ground the value of the American currency, and by extension, every other currency pegged to it.
THE DXY
If a currency is not tied to anything, then what gives it value? The many answers to this question fall outside of the scope of this article so let us turn instead to the answer provided by the Federal Reserve. Their solution to this new problem was to create an index that weighed the strength of the Dollar against the currencies of the US’ most common trading partners.
At the time of its implementation in 1973, this meant the inclusion of the following 10 currencies: the Japanese Yen, the Canadian Dollar, the Deutschmark, the Pound Sterling, the Italian Lira, the Dutch Guilder, the Swedish Krona and the French, Belgian and Swiss Francs. After the adoption of the Euro by many European nations around the turn of the millennium, the basket consolidated from 10 currencies down to the current six according to the following ratio:
Taking the above weightings into account, the formula for calculating the DXY is as follows:
One may notice the negative exponent for the Euro and Cable. We leave the reasoning as to why as an exercise for the reader. The purpose of the constant is to peg the first calculation to a value of 100. The index is therefore to be read as follows: a value below 100 is to be understood as an indication of a weak Dollar; and the obvious corollary.
Although established by the Fed, the task of calculating the DXY currently falls to the Intercontinental Exchange (ICE), which introduced a tradeable futures contract tied to the index back in 1985. It would be during this very year that the DXY printed its highest ever value, coming in just shy of 164.
In contrast, the period surrounding the 2008 financial crisis was characterised by lower interest rates in the US compared to other countries, comparatively devaluing the Dollar and causing the DXY to fall as low as 70 in the first half of that year.
CRITICISM
The index has not changed in its composition since its introduction half a century ago. The Euro merely substituted the currencies it replaced, taking their combined weighting as its own. This is the source of much of the criticism currently levelled against the DXY. The world has changed considerably since 1973, economically and otherwise. Let us remind ourselves that the currency basket of the DXY was defined by the largest trading partners of the United States at the time, which as of 2021 stood as follows:
As we can see, the composition of the DXY doesn’t follow the above chart at all. Despite making up 57% of the weighting of the basket, the truth is that only 15% of US trade occurred with Eurozone countries. Meanwhile, due to its strongly emergent economy and solid manufacturing base, trade with Mexico continues to ramp up, now challenging China and Canada for the top spot.
If the index is meant to be a reflection of the strength of the Dollar on the world stage, then why does it not include the Mexican Peso, or indeed the Chinese Renminbi, or even the Korean Won? Conversely, and with absolutely no offense to Sweden, is the inclusion of the Swedish Krona really justified in this day and age?
The other, perhaps more fundamental criticism, is that none of this matters because none of the currencies mentioned in this article have any inherent value anyway. By definition, the DXY tells us the relative value of the Dollar compared to other currencies. The problem being that all of these currencies are locked in a race to the bottom, relentlessly eroded by inflation, year after year. 35 bucks certainly won’t buy an ounce of gold anymore.
Overly harsh criticism no doubt. The DXY remains ubiquitous in the financial world in no small part because of its use to traders. Given that the USD is on one side of almost 90% of all forex trades, it can more than justify its own index. Although perhaps one more grounded in the present day.
On occasion, during a brief whimsical moment, you may focus your attention on a coin and wonder how many times that round piece of metal has changed hands before ending up in the palm of your own. You look at the mint date, raising your eyebrows almost imperceptibly, vaguely taking note. The moment passes.
A single coin, used in innumerable transactions, fungible and yet unique in its own right. But what is it really? After all, the physical coin is just a tool, no more than a means of exchange. How old is the money itself? How long has this particular currency been in circulation? The sobering answer is that many currencies have outlived centuries worth of political strife. They are an unnoticed and underappreciated element of stability for nation states and empires alike; an age-spanning constant. Let us take a closer look at the three oldest still in circulation today.
Let’s get the weird one over with first. Number three on the list is none other than the Serbian Dinar. You heard that right. A country that most people would struggle to point to on a map has one of the oldest currencies in the world. Its usage dates back to the thirteenth century, to 1214 if historical records are to be trusted.
Serbian Dinars were silver coins heavily inspired by the nearby Venetian currency, which were in turn derived from Roman coinage. For some reason, Serbian rulers really liked the idea of seeing their face on their coins, so much so that most of them minted their very own pieces of silver bearing their resemblance. Unfortunately, such vanity only persisted for so long before the Ottoman Empire waltzed in and occupied the area for the next four hundred years. History has not been kind to this part of the world.
The Dinar would have to wait until 1868 to make a comeback but it would be short-lived, being replaced by the Yugoslav Dinar in 1920. The Serbian dinar came back to life once again in 2003 after Yugoslavia turned into the State Union of Serbia and Montenegro. Although funnily enough Montenegro decided to adopt the Euro instead. Maybe they thought the Dinar was cursed.
The second oldest currency is the Russian Ruble and it dates back to roughly the same time frame. The name is said to have come from the word “rubit”, meaning to cut or chop, because Rubles were originally cut from a rod-shaped piece of silver called a Grivna, the standard money of North-Eastern European lands of the time. From its earliest origins, the Ruble has been tied to silver, although the exact conversion rate wouldn’t be standardised until 1704, when Peter the Great reformed the monetary system of the Russian Empire and minted 28-gram silver Ruble coins.
The coins were divisible into 100 copper kopeks, making the Russian Ruble the first ever decimal currency, in stark contrast to the numismatic shenanigans we’ll get to later. The name would go on to survive the Russian revolution of 1917, becoming the currency of the Soviet Union until its eventual collapse in the 1990s, then becoming the currency of the Russian Federation. The “₽” symbol for the Ruble was only officially adopted by the Central Bank of Russia in 2013 following a public poll, in an attempt to emulate the designs of other major currencies.
Drumroll for the number one oldest currency still in circulation: the Pound Sterling. Astoundingly, usage of the Pound dates back over a millennium to the early dark ages, around the year 800. The Roman Empire had a well-established and well-understood coinage system that spanned the breadth of its territories, including the British Isles. Unfortunately, the typically murky conditions following the fall of Rome in the fifth century are somewhat more difficult to make sense of.
It would take a few hundred years before a new dominant currency would be established, and the credit for this feat is generally attributed to King Offa of Mercia. Besides having a really cool name, Offa’s greatest accomplishment would be the standardised minting of silver pennies in large quantities, the use of which would become widespread throughout his lands. The weight of 240 such silver pennies added up to a Saxon Pound (roughly 350 grams), which is how the weight of a Pound Sterling was first defined. The “£” symbol derives from the upper-case Latin letter “L”, which stands for “Libra”, meaning scales.
Usage of these coins continued relatively uninterrupted over the next few centuries, with subsequent monarchs adding their own little personal touches. The earliest coins were minted from fine silver, which was a problem because pure silver is actually very soft, so these coins weren’t very durable. Henry II changed this in the 12th century by establishing the usage of Sterling silver, defined as 92.5% silver by weight. This metallurgical standard remains in place to this day.
The Penny and Pound wouldn’t be the only units of account to come into being during this time, many of the pre-decimal units also date back centuries. Copying the Carolingian system from the Franks, the Pound was divided into 20 shillings and the Penny into four farthings or two halfpennies. Other insane denominations would follow, including the florin, crown, half-crown, farthing, sovereign and guinea. Decimalisation in 1971 eradicated them all.
The origins of the word Sterling aren’t as clear cut. Some say the term derives from the word “steorling”, meaning “little star”, a design element which featured on the earliest Norman pennies. It’s a nice story so let’s stick with it.
Usage of the Penny and Pound would continue without interruption until the present day, the only real change being the weight of silver the coins represented. Over the course of its existence, the Pound Sterling has been continuously devalued, making up lesser and lesser amounts of silver, up until the present day where it technically isn’t redeemable for anything. Inflation has been around for a long, long time. King Offa is probably spinning in his grave.
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