With the decline in the dollar's value relative to other currencies, there has been a surge of interest in the euro. This article explains the various investment options available, an exchange rate example, as well as the risks associated with the euro.
Before all credibility in the financial community is lost, it's important to note the correct title of this article should be Investing in Euro. A quick visit to the official site of the euro explains the official term for the currency in the singular and plural form is euro. But even the official website acknowledges that some languages, such as English, may use the term euros. As a side note, the term Eurodollar is not an official term of any kind for the euro, but a reference to dollars held in European banks.
There are two types of currency used in the European community: the euro and the cent. Just like in America, there are 100 cents (or cent) in one euro. The practical benefit of the euro is that people can travel throughout Europe and use a same standard currency.
One of the misconceptions is that it would be standardized against the U.S. dollar in terms of its value. This is not true, and this is what makes investing in euro so intriguing.
The euro is currently trading around $1.17 USD (October 2020). This is often referred to as the exchange rate. This means it costs $1.17 to purchase one euro. About five years ago, euro was trading at around $1.11. This demonstrates the euro is not fixed to the dollar, and there is an opportunity to make or lose money from the change in the exchange rate over time.
This is one reason investors would be interested in euro. If the relative value of the dollar rises or falls, the investor can make money from this change.
In a global economy, countries compete with each other for the sales of goods and services. But the problem for trade partners is figuring out the relative value of each currency. One of the major factors affecting the value of a currency is the faith in a country's economy. If one country's economy is weakening relative to another, then over time, there should be a change in the exchange rate.
If investors believe the dollar will weaken against the euro, they think euro will be worth more in the future in terms of dollars. Over the past year, that is exactly what happened. If an investor purchased $111 one year ago, it would have cost 100 euro. Trading 100 euro for dollars today would yield $117. Investors would have realized a loss of $6.00, which is a 5.4% gain on the $111 investment in only one year.
In order to combat inflation here in the United States, the Federal Reserve has been keeping interest rates relatively low. Specifically, they have been low relative to interest rates found in Europe. This brings up the second reason for investing in euro: Taking advantage of higher interest rates in Europe relative to the United States.
For example, let's assume that a two year government bond in the U.S. yields around 3.4%, but a two year bond for the U.K. is yielding 4.5%. That is roughly a 1% spread in interest rates. By taking U.S. dollars and buying foreign government bonds, in euro, the investor has a second chance to earn a higher return on their investment.
When someone invests in a foreign currency, they are placing a bet the euro will grow in value relative to the dollar. Before placing a bet like that, they need to understand the relationship over the past several years and try to predict what might happen in the future. In this example, the euro has weakened versus the dollar over the last nineteen months. The question is: Can this trend continue; will it turn around, and for how long?
To a certain degree, it's possible to compare the relative strengths of each country by examining the health of their economies. The United States is running up some very big trade deficits, and the national debt is growing at an incredible rate.
While many Americans might believe their country will eventually repay all these loans; foreign countries are not quite as confident. When the U.S. is seen as a relatively risky investment, then other countries will want to be compensated for the increased risk, if the world agrees, then the euro will increase in value relative to the dollar. In the same way, an economic crisis in Europe would cause the euro to fall relative to the dollar.
There are several options an individual has to invest in the relative movement of the euro:
Trading in foreign currency is viewed by many as speculation, although it can be used as a hedge too. We have an entire article dedicated to the topic of forex currency trading, which talks about the risks and rewards associated with this exciting and controversial investment opportunity.
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