How To Analyze The Currency Markets

Joe Weisenthal (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast.

Tracy Alloway (0:16)

And I'm Tracy Alloway.

Joe Weisenthal (0:18)

Tracy, have you ever noticed, like, we've had all this market volatility lately, and regardless of what we're talking about, it feels like the action that we see in the trading of the US dollar is central to almost every conversation that we have.

Tracy Alloway (0:33)

Yeah, that's true. It certainly feels like, well, from my position in this part of the world, in Hong Kong, very close to China, it feels like a lot of the emerging market volatility and weakness has definitely been pinned on the dollar recently.

Joe Weisenthal (0:47)

Right, exactly. And it's also kind of weird because basically everything is priced in dollars.

So I've always had a hard time wrapping my head around what is a move in the US dollar versus what is other stuff moving around priced in the US dollar. Does that make sense?

Tracy Alloway (1:08)

Oh, no, this sounds like a currencies episode. And you know that currencies are my least favorite thing to talk about, because as you point out, everything is always relative.

Joe Weisenthal (1:17)

Right. It's kind of like if you're standing on Earth, then you say, oh, the sun is rising and the sun is falling, depending on the time of the day. But we know that in the universe, the sun doesn't actually move at all and everything moves around it. And I've always sort of kind of thought of the dollar this way. Like sometimes we talk about the dollar going up and down, but sometimes it seems like it might make sense to just talk about everything else that's priced relative to the dollar. And the conversation always kind of hurts my head.

Tracy Alloway (1:47)

I would broadly agree with that. And of course, the financial system revolves around the dollar, and the dollar holds that very special position in the financial system, which is that it is the world's reserve currency, which gives it an extra layer of complexity. Isn't that fun?

Joe Weisenthal (2:02)

Yeah, so both of us get our head hurt by currency conversations and trying to wrap our head around the role of the dollar in the financial system. So I'm very excited about the guest we have on today. We're going to talk about how to think about valuing currencies, how to think about valuing the dollar, with a long-time veteran expert in the world of currencies.

He is Mark Chandler, he's a managing partner at Bannockburn Global Forex, and he is going to break it all down for us today. So Mark, thank you very much for joining us.

Mark Chandler (2:39)

Thank you. I don't know about your headaches, but I can tell you this, that there's two types of people, I think, in the world, people who give headaches and people who get headaches, and I'm a giver.

Joe Weisenthal (2:46)

You're going to give us both headaches?

Mark Chandler (2:47)

Both headaches.

Joe Weisenthal (2:48)

I thought you were going to be here to relieve our headaches.

Mark Chandler (2:51)

That's the incredible thing is how complicated foreign exchange is.

Joe Weisenthal (2:55)

Yeah.

Mark Chandler (2:55)

And I think that you put two currency strategists, and you'll get three different opinions. And I think that that's the challenge. I think that you guys hit it in the sense that currencies are central, the dollar is central, but valuation, you know, when you think about stocks and bonds, there's a clear model of valuation, either an earning stream, free cash flow, breakup value, replacement costs, all more or less agreed upon models to evaluate equities. And you can do the same thing with fixed income. MBAs, economists can project the future value of the earning stream.

But it comes to currencies in their pure form, they don't have an earning stream. You can turn them into a deposit and then they have yields, and then we can talk about interest rate differentials. But in their pure form, we live in an era of fiat currencies, where money has no value except the value we give it. It's not backed by gold or silver anymore, it's not backed by commodities, they're free-floating for the most part as major currencies.

And so valuation becomes much more elusive.

I think that's what a source of headaches for people, not only all the other problems, but the valuation.

Joe Weisenthal (3:55)

I think you hit the nail on the head why both Tracy and I get headaches talking about this topic.

Tracy Alloway (4:00)

Okay, so on that note, I mean, you just mentioned, Mark, that unlike a stock or a bond that generates some sort of cash flow, currencies aren't really doing that. So how do you go about valuing currencies, and does the value of a currency have to come from it moving up against something else?