The US dollar pegged to the yuan

[henry766]

Hi Atilla , if the U.S. economy slows you think dollar will tend to rise , maybe , isn't the consensus weak economies mean weaker currencies , not saying that's true ..didn't japan have a strong currency and weak economy for years ? with a weak U.S. economy people will be less keen to hold dollars for sure , which will weaken currency as investors leave U.S. shores , also a weak economy may tend to have slightly higher inflation in general as the central bank comes under pressure to keep interest rates a little lower than they might otherwise , plus like you say makes all imports more pricey and in longer term leads to wage inflation as domestic labour cheaper than elswhere , thus increasing demand in a sense . The effects of investors leaving and the currency weakening are sort of self balancing as investment will get more attractive the lower the dollar gets , ( plus makes us industries seem more price competitive )so yeh may weaken , but unlikely to fall through floor!!here's another thing though , apart from adding this all up , in the short term what people think makes a difference , if the u.s. economy is perceived to be in trouble investment and buying of dollars will dry up some , self fulfilling prophecy to some extent , but this weakening may be temporary ,and like you say , real returns maybe rise as the currency sinks because of percieved value in the future , in a sense real interest rates atleast for an investor are more like interest rates + or - ( depending if currency is percieved to be rising/ falling in future ) future currency movement ( the currency movement is sort of subjective , but there is a consensus of sorts in the currency futures etc

 

[Atilla]

Hi Atilla , if the U.S. economy slows you think dollar will tend to rise , maybe , isn't the consensus weak economies mean weaker currencies , not saying that's true ..didn't japan have a strong currency and weak economy for years ? with a weak U.S. economy people will be less keen to hold dollars for sure , which will weaken currency as investors leave U.S. shores , also a weak economy may tend to have slightly higher inflation in general as the central bank comes under pressure to keep interest rates a little lower than they might otherwise , plus like you say makes all imports more pricey and in longer term leads to wage inflation as domestic labour cheaper than elswhere , thus increasing demand in a sense . The effects of investors leaving and the currency weakening are sort of self balancing as investment will get more attractive the lower the dollar gets , ( plus makes us industries seem more price competitive )so yeh may weaken , but unlikely to fall through floor!!here's another thing though , apart from adding this all up , in the short term what people think makes a difference , if the u.s. economy is perceived to be in trouble investment and buying of dollars will dry up some , self fulfilling prophecy to some extent , but this weakening may be temporary ,and like you say , real returns maybe rise as the currency sinks because of percieved value in the future , in a sense real interest rates atleast for an investor are more like interest rates + or - ( depending if currency is percieved to be rising/ falling in future ) future currency movement ( the currency movement is sort of subjective , but there is a consensus of sorts in the currency futures etc

Forgive me if I'm stating the obvious below but to put heavy debate into some simple context here are some more relationships.

The $ is determined ultimately by Balance of Payments - as it is an exchange rate with other currencies.

Inflation is determined by excess supply of money > goods available.

Interest rate is determined by Investment and Savings. However, governments use it to control supply and demand for money instead.

Weak economies -> weak exports -> weaker currency = Yes

But

Weak economies -> weak imports -> strong exports = Strong currency.

Depends of BoP status. -ve or +ve.

Japan had a strengthening currency because literally for decades it ran a +ve BoP. It then went and spent billions literally buying assets abroad. All good for Japan really.

People will hold $ providing it doesn't lose value or they are compensated by interest payments.

Weak or slow economies usually have low inflation not high.

The US economy is in a special situation at the mo. In consequence of the Bush administration, cutting taxes, zero real rates and spending $500 bn on a fuddy duddy war and maintaining v.low interest rates for good many years has unleashed lots of $ with insufficient goods to compensate... I recently read the Bush Admin will not incorporate the Iraq war in their budget calculations + reduce the Sarbane Oxley checks on big corp. Hence, if you pump billions into a slowing economy due to saturated demand you get stagflation - inflation with reduced growth. Once again this is the exception.

Even today the markets have surged and I have no idea why? Weak housing & manufacturing seems to have been over shadowed with couple of good earnings and a bit of a frisky price index. Based on fundamentals it is inexplicable. A lot of cash and a big party is going to lead to big headache next year.

 

[henry766]

Surely money supply also Atilla , if a government starts printing money that will weaken currency irrespective of balance of payments?

 

[henry766]

doesn't the u.s. have a very negative balance of payments with china? and yet the doller still buys more in china than visa v?

 

[Atilla]

Surely money supply also Atilla , if a government starts printing money that will weaken currency irrespective of balance of payments?

Yes true but an important consideration for the US...

Being an international currency, the US has a $ reputation to maintain. Favours might be running out. Be interesting to see what comes out of the US China talks.

 

[Atilla]

doesn't the u.s. have a very negative balance of payments with china? and yet the doller still buys more in china than visa v?

For now yes. In several years time the Yuan will appreciate against the $. I think we have already seen some movement at recently.

As I mentioned before I think this is the US shifting it's weight in an economic battle. Virtually daring international $ holders to support the $ or lose the value of their $ holdings. It's playing a silly game in my opinion. It's losing or will lose. Needs to check it's weight and obesity. That means controlling it's Budget defecit and BoP.

China is buying gold and spending it's $ investing in Africa and Latin America. Similar to Japan. It is diversifying out of the $. When the time comes the $ will drop like a brick if it does not check it's finances.

 

[henry766]

just nitpicking!! helps me understand though, good luck

 

[Atilla]

just nitpicking!! helps me understand though, good luck

It's always good to test these $, r, i, relationships etc.

They are all related and the sticky point is the magnitude of these relationships which have always been up for debate, and econometric testing.

Here is an intereting article...

No deal for US-China trade gap...

 

[henry766]

It is a complex business predicting currency movements based on fundamentals , ( didn't lamont get himself into trouble on this) , to me, one of the main problems is time scale , if a currency drops in value , it will do so until returns ( for traders /investors)in the future are seen to be higher , but trying to work out when and where it will go is tough ( atleast to me ).

 

[Atilla]

It is a complex business predicting currency movements based on fundamentals , ( didn't lamont get himself into trouble on this) , to me, one of the main problems is time scale , if a currency drops in value , it will do so until returns ( for traders /investors)in the future are seen to be higher , but trying to work out when and where it will go is tough ( atleast to me ).

Yes I remember well. interest rates at 15%. Negative equity and the lot.

If I may add, Lawson I thought was a brilliant chancellor was staunted by Thatchers phobia of the European Monetary System EMS... Because the £ was not allowed to join the EMS where it would have been supported by all the other European banks, Lawson decided to emulate it by playing with interest rates to peg it in a 3% band againts the DM. This led to 7.5 % interest rates and inflationary pressures and some nasty consequences.

With Lamont, the £2.95 = DM was fixed at an artificially high rate as UK economy was not up to the job. The world knew but the UK government wouldn't budge. Hence, one non supportive comment from the Deutch Bank and the £ was undermined. However, it was obvious to most. It floated down to £2.22=DM if I recall correctly before moving back up to around £2.40 something. Not sure how it rates now as DM is no more.

I would agree fundamentals are not accurate predictions in the short-term but they are consistent for long-term guides. As you say it depends on your time frame.