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In the Currency Markets, Don’t be Fooled By Randomness

“The dollar traded near a three-month high against the euro on signs the global economic recovery is gaining traction,” we read on Bloomberg this morning.  Excuse us?  Let’s make sure we understand  this correctly; the world economy is improving, and so the dollar rose?

See, that’s odd because for the past nine months, the headlines have read some variation of “Dollar falls as risk appetites return and global economy recovers.”

So…an improving economy causes the dollar to fall until it causes it to rise.  That makes sense.

Nassim Nicholas Taleb, author of Fooled by Randomness, would have a field day with this.   (We’ve always considered Fooled to be quite a bit better than his more recent The Black Swan.)  Taleb dedicated quite a bit of the book to poking fun at the financial press, specifically their tendency to confuse correlation with causation.  In this case, the dollar is going up and the world economy is improving, therefore the dollar is going up because the world economy is improving.  This is not to say that financial journalists are stupid; far from it.  But the economics of the industry pressure them to “put the pieces together.”  Humans shy away from complexity.  They like absolute answers, not ambiguities.  And frankly, no one would buy a newspaper that read “the dollar rose (or fell) today, but it is most likely statistical noise with no significant meaning.”

Legendary trader George Soros had his own take on this.  Soros is credited with saying that the secret to making money in the markets is to find the trend whose premise is false, and bet against it.   We’ve made our case very clear on this — we believe that the dollar’s decline in recent years has been based on several false premises and that from a valuation and psychological standpoint, the greenback actually looks quite attractive.

Meanwhile, bad news continues to pour in on euro: “ECB Sees Rising Bank Losses in Euro Zone”

Banks in the euro zone face much higher losses than previously thought, mainly from their exposure to Eastern Europe and commercial real estate, the European Central Bank said….

A dearth of credit for households and businesses could undermine the region’s recovery prospects by keeping a lid on spending, which is the main source of economic activity in the region. That should keep ECB interest rates at record-low levels well into next year, economists said.

Sounds familiar. Funny that these trends were ignored with respect to the euro for virtually all of 2009 while they were obsessed over with respect to the dollar. What was that Mr. Soros said?  Something about false premises?

Related posts: “The Destruction of the Dollar?  Not So Fast,” “Must the Dollar Fall  If Stocks Rise?”

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy