The dollar super-cycle

The regime of floating currencies ushered in by the breakdown of the Bretton Woods agreement and symbolized by President Nixon’s decision to sever the dollar’s peg to gold turns 35 years old on Aug. 15, 2006.

Despite their current prevalence, floating exchange rates are nearly unprecedented in the past half millennium of capitalism and, as various officials including former Federal Reserve Chairman Alan Greenspan have pointed out, predicting their movement is a rogue’s game. At best, forecasting currency movements is a Herculean task. At worst, it is a Sysiphusian occupation. Nonetheless, given the importance of currency movements for businesses, investors, and speculators, many people have little choice but to make the effort.

Both interest rates and exchange rates reflect dimensions of the cost of money. This relationship, however, is not necessarily linear, which is what Wall Street economists continually rediscover with their myriad studies that find weak correlations between interest rates and the dollar. Examination of the data suggests a more cyclical relationship.

Specifically, it appears the dollareuro (and before the euro, the dollar deutsche mark) has completed three cycles since the late 70s and has begun a fourth. However, what is proposed here is not a grand, unified theory of currency movement. The model and findings are limited to one currency pair, albeit the most actively traded pair in the $2 trillion a day forex market.