Currency war

I understand the prediction about the dollar and it makes sense, but so do the financial pundits' opinions about the stock market, and they are right no more than your proverbial roll of the dice. It seems to me that international currency markets are still too unpredictable to bank on. Too many unforeseeable events in the world can shake up currencies. In order to come out ahead, you have to guess right, and guess right big enough to cover the cost of pre-ordering and the opportunity costs while your euros sit in a drawer. For me, my 'currency speculation' is the baggies of left over euros, pounds, Chinese yuan, yen etc. that I have from my last trips waiting for me when I head out again.

I think the best strategy is to focus on where you want to go and what you want to do, and not waste time worrying about something no one can predict: currency fluctuations.

I agree with Tom. In the grand scheme of things, the amount you might lose or gain is relatively inconsequential relative to the cost of your whole trip. Of course, big spenders would conceivable save or lose more, but I don't worry as much about exchange rates as I do bank fees and other things that I can control costwise. And if your money is tied up in euros you are losing interest you could be earning on it for only a potential gain.

All sensible comments. On the other hand (I'm playing devil's advocate) if you know for a fact that you will be traveling next year and you buy some euros now, you are insuring yourself against a possible drop in buying power of 20 or 30 percent (or heaven forbid, more.) Remember, the euro and dollar started out at 1-to-1, then the dollar lost 30 percent of its value. Today 1 dollar buys 0.72 euros, if next summer 1 dollar only buys 0.50 euros, that's a loss again of something like 30%. (The $1 dollar = €0.50 is not unreasonable) That means next summer's trip just got about 30% more expensive. However, if you just keep the money in the bank, you'll optimistically earn like 2 or 3% interest on it. Of course, the devaluation of the dollar could be less or more than depicted in this scenario. The dollar could turn around and be worth more than the euro next year, though that's unlikely. And then, as was mentioned, there is also opportunity cost. If you need that money now to buy Christmas presents, then you don't want to tie it up in Euros. But if you have the extra dough and you know for sure that you are going to Europe next summer, and you are fairly sure that the combined influences of increased U.S. debt and increased investment in places like India will continue to drive the dollar down, then buying a few euros now and sticking them in your sock drawer might not be a bad idea. I say all this remembering how people were screaming the last time the dollar tumbled. I feel fairly certain that Rick's business is also nervously keeping an eye on the situation.

Like my mom says, "IF is a big word."

Thomas, good point for discussion! I'm planning to return to Europe again next year, but don't usually worry about the exchange rates. "They are what they are", and that's just part of my trip budget. In my travels so far there haven't been huge fluctuations, so the differences have been minimal. I haven't checked but it would be interesting to see what the futures markets are predicting? Cheers!

We also should keep in mind the pound, the exchange rate for which has been more expensive than the euro for years now. .... And we don't know what will happen with the European economy down the road, either. Many of us didn't expect that Greece would need a bailout from the EU, which caused the euro to fall against the dollar. ... I'm echoing much of the advice given here - right before your trip, exchange money for maybe 100 euros (or pounds) so you'll have some money before you arrive.

In my opinion, speculating on currency values in advance of a trip doesn't make much sense unless you are talking about big amounts. Here is an example. Today, you can get Euros for dollars at around 1.38, from an ATM in Europe. Let's call it 1.40 for simplicity. Now, let's say the Euro goes up to 1.50 before next summer. If you bought 5,000 Euros today for a trip next summer, that would cost you $7,000 at 1.40. If instead you waited and bought the Euros next summer, that would cost you $7,500. So, by buying in advance, you only saved $500. Sure, $500 is a nice profit, but is it really enough to make speculation worth it? I don't think so. My point is, the Euro may go up in the next year, but I don't think it is likely to go up so much that buying a lot of Euros now will make a big difference in your trip costs.

Marry rich.

To add to Tylers point, his example is best case. In the US, you will not get European ATM rates. If the ATM rate is $1.40, you will more likely pay $1.45 to $1.47 here, further eroding any gain. If you then add in the "Time Value of Money" meaning that money has the opportunity to gain interest in some investments, or if you really blow your economics, you pay interest to borrow that money for the time period (loan or credit card) then the risk to buy ahead is even greater and any gains in exchange rate are likely to be offset.

Thomas, you posit a loss of 30% of the value of a dollar against the euro in the next year? That would be a fall of epic proportions. Over several years, perhaps, but it is hard to see that kind of fall in a short period, particularly when the European economies have their own sets of monetary policy challenges. It's possible to bet on this kind of unprecedented currency move, but I'm not sure that's where the smart money is. If you google more generally for euro-dollar exchange rate predictions, you'll see financial analysts estimates are all over the map, with most within a fairly narrow range not markedly different from recent years. I feel about currency speculation the way I do about horse racing: if it gives you enjoyment, go ahead and play, but don't count on coming up with a system that guarantees you come out ahead.

Thomas says: "Prepaying is very smart, I think." A few years ago, I had the crazy idea that buying some Euros and Pounds from time to time, as the exchange rates seemed favorable, and putting them in bank accounts in London and Barcelona would be a way to save for vacations. The theory was, I will get interest on the money that will offset currency fluctuations. In London, I opened a Pounds savings account at Citibank that was paying almost six percent. That was great, until the financial crisis hit, and the interest rate had dropped to about 0.8 percent. And, of course, the value of the Pound has plummeted, too. It's just a really bad time for consumer savings, everywhere. The only place you can make any money right now is the stock market.

It isn't all one-sided against the dollar. There is also a case where the euro could fall in value. Anyone recall the Greek debt problem? It's quiet now, but still there, as is Ireland, Portugal, Spain and maybe others I haven't heard of. Financial stress plus social unrest over sovereign budget cuts could put pressure on the entire eiro zone as the North will go only so far to bail out "Club Med." Big money might get nervous and decide to go elsewhere. Not a prediction, but a possibility.

Thanks everyone! What a great high quality discussion. I think we have done our job: raising the issue of possible currency turbulence in the next few months and discussing the pros and cons of various courses of action. Of course, unless you can accurately foresee the future, there is no "right" answer that will fit everyone's circumstances. (Although I liked the advice to "marry rich".) One last note: Here's an article from yesterday's Wall Street Journal: http://blogs.wsj.com/source/2010/10/07/a-zero-sum-game-where-everyones-a-loser/ The operative statement from the article: "the (U.S.) Federal Reserve has been doing everything it can to depreciate the dollar."

Thomas, "the (U.S.) Federal Reserve has been doing everything it can to depreciate the dollar." That's probably why the Canadian dollar is once again inching close to parity. Hopefully it will stay that way for awhile, as it will help with expenses on my next mid-winter sun break!

One thing I'm surprised I didn't see here is the concept of "dollar cost averaging" like with stocks. Where you buy a fixed dollar amount of something each month. So, for example, you buy $200 worth of euros each month. Some months you get more euros than others. Then, after a year, you've purchased $2400 worth of euros at the average over the year. Assuming the dollar is valued at lower than when you started, you're ahead of the game. But then when you realized there's actually a cost associated with changing money, it's really hard to see this as advantageous. Unless you've got a fee-free way to exchange. The other way to protect against the dollar deflation is to pre-pay as much of your vacation as you can. Hotel, car rental, air fare, etc.

Prepaying is very smart, I think. Assuming the traveller is certain the trip will not be cancelled. As for transaction fees when you exchange money, I suppose you will be hit with them one way or another, at one time or another. So, it might kinda net out of the calculation as to whether to risk buying now or risk buying later.

Here is the latest as of 11 November. It does indeed look like Europes going to be more expensive for dollar-based travelers next summer. http://www.ft.com/cms/s/0/b6e3d086-ed12-11df-9912-00144feab49a.html#axzz14xMH7VmG

One advantage to buying another currency is that it makes that money untouchable. If you are the type of person who may fritter money away it might be a good savings plan. You could still re-convert it if you lost your job and needed to pay the mortgage, but you won't go buy new clothes with the euros.

Another option would be to buy a Euro ETF to hedge against the potential increase in the cost of the Euro. That way, if the price of the Euro increases, the value of your ETF goes up. Otherwise, the fees involved in exchanging currency in the U.S. can cost a lot more than getting money from an ATM when you arrive in Europe. A typical Euro ETF if the symbol FXE.

It's been another volatile week of ups and downs. Google "euro dollar exchange forecasts" today and the pundits are predicting a rise in value of the dollar against the euro and pound and a fall against the Canadian dollar by the summer. Probably next month the predictions will be something else. For an interesting take on why currency predictions are so inaccurate, those with access to academic journal databases might want to read Fordham economist Dominisk Salvatore's article, "The Euro-Dollar Exchange Rate Defies Prediction," Journal of Policy Modeling 27: 455-464 (2005). For those of us without such access, the abstract is online. His main point is that currency modeling "is unable to consider all the fundamental forces at work and the fact that news and other unexpected events have been practically impossible to model precisely." Probably the best currency hedge, for those still inclined to play, is to prepay expenses, as long as the hotel will give you a reasonable exchange rate. Unfortunately this is often not the case. I have sometimes prepaid expenses, not for the currency hedge, but just because paying some of the costs early makes the later "bite" of paying down my trip after the fact a bit less painful. Another option might be to buy euros from a friend who may have some leftover euros but who is not planning a trip in the near term future. We actually did that in reverse--we sold excess Australian dollars to a friend going to Australia since we weren't planning a return trip in the foreseeable future. He made out well, since the Aussie dollar strengthened significantly afterwards. And we were happy to be rid of currency we knew we probably weren't going to use, without giving the bank a big fee for the privilege of relieving us of it.