The Mechanics of a weaker/stronger currency

millermandil

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Hi There. Could someone please explain to me the mechanics of 'one currency being stronger/weaker compared to another currency/ other currencies' and what impact does this have on the stock market internationally? Im learning about the US Commodities market, so if possible, specifically in relation to the latter.

Furthermore, how does a currency become weaker/stronger...GDP?, economic growth?, interest rates? Employment?...

Thanks.
 
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Wow! That's a question with some teeth. Let me see if I can offer up something.

The value of one currency in relation to another is based on a number of factors. Comparative interest rates is one very important one. Economic strength (as measured by GDP) is another. Obviously, from a supply/demand perspective, trade flow is important. Really what it boils down to, though, is capital flow. Countries that attract investment will have stronger currencies. There is also the reserve factor. Countries, like the US, with currencies that are considered reserve in the international financial community. Those currencies tend to hold a premium.

The biggest direct influences on short to intermediate term currency valuations tend to be interest rate changes, trade figures, and any economic released deemed to give a read on where the ecomony and interest rates could be headed (in the US, the monthly employment data release is big).

From my experience, psychology plays a bigger role in forex than in pretty much any other market. Self-perpetuating trends are the pattern.

In terms of the commodity markets, international commodities like oil and gold are priced in US Dollars. That means there is an inverse relationship between the value of the Dollar against other currencies and the price of those markets. Obviously, that's not the only factor, but it can be a big influence at times.

As to the equity markets, a the strength or weakness of a countries currency (more specifically, the expected strength or weakness) can influence market changes. If a currency is seen to be strong, it will attract foreign investment. The reverse, obviously, is true for weak currency situations.

I hope this helps at least a litte.
 
Warren Buffett's letters to shareholders at times read like scripts from The Waltons TV show. But the billionaire fund manager's folksy style is a breath of fresh air for currency investors used to the obfuscation of Alan Greenspan, chairman of the Federal Reserve.

Mr Buffett believes the dollar has further to fall and the US trade deficit risks turning America into a "sharecropper's society". It is only fair to point out that the chairman of Berkshire Hathaway is talking his own book. The value of the group's foreign exchange contracts mostly short positions against the dollar increased to $21.4bn at December 31 2004 from $12bn the previous year. That caveat aside, Mr Buffett's reasoning has merit.

Some might argue that while foreigners are happy to finance the US deficit by recycling their corresponding surpluses into dollar assets the situation is sustainable. But, as Mr Buffett's sharecropping analogy highlights, that argument ignores the transfer of wealth that accompanies persistent large trade deficits. US net external liabilities are currently about three times export earnings. With a trade deficit amounting to 5.4 per cent of gross domestic product, net indebtedness continues to grow. It is unlikely that America can trade its way out of the problem. Since 1991, the share of exports in US GDP has remained static, at close to 10 per cent, while the share of imports has jumped by five percentage points.

Not all of the transfer of wealth to the rest of the world leaves US control. Part of the deficit reflects trade between US-based companies and their overseas subsidiaries. But it has been the willingness of foreign central banks, particularly in Asia, to accumulate currency reserves that has allowed the deficit to persist without more significant dollar depreciation. As US indebtedness grows, so does the risk that its creditors' appetite for dollar assets wanes or they at least require a higher return. The dollar has already proved sensitive to suggestions that South Korea might diversify the currencies in which it holds its foreign exchange reserves. In Mr Buffett's words, US "spendthrift behaviour won't be tolerated indefinitely
 
Whom to believe -- Buffett or Greenspan?


The Oracle of Omaha foresees dire consequences for our debt-ridden ways. The Fed chairman predicts a soft landing and says the debt is no big deal. Who's right?

By Jim Jubak

The Oracle versus the Chairman. In terms of heavyweight bouts, they don’t get much bigger than this. What these two champions of capitalism are slugging it out over is no less than the future of the U.S. economy.

Warren Buffett, the Oracle of Omaha and the CEO of Berkshire Hathaway (BRK.A, news, msgs), charges the United States is headed for a massive dollar crisis caused by a trade deficit running at better than $600 billion annually. Bam! Alan Greenspan, chairman of the U.S. Federal Reserve, counters the economy is headed for a soft landing and the debt owed to foreign investors and savers is no big deal. Smack!

One of these guys is wrong. Before telling you who I’m putting my money on, let me put the two head to head so you can make your own call.

First, the numbers
Nobody has a better command of the data on the current state of the economy than Greenspan. And the picture he paints by his numbers isn't pretty. The national personal saving rate has plunged to an average of 1% in 2004, shockingly below the 7% average for the last three decades.

Indeed, we've been running up debt like there's no tomorrow. The unified federal budget (which is the budget that includes the current Social Security surpluses) is running a deficit equal to about 3.5% of gross domestic product. That deficit is only going to climb as outlays for Social Security, Medicare and Medicaid, now 8% of gross domestic product, climb to somewhere near 13% by 2030 as the baby boom generation ages and retires.

Meanwhile, the U.S. current account deficit, a measure of how much more we buy from foreigners than we sell to them, has climbed to 6% of gross domestic product. According to the Fed’s economists, you have to go back to the 19th century to find larger current account deficits as a percentage of the size of a country's economy. All this debt has been funded by an increase in the value of homes (and the size of home mortgages) on the domestic side, and the willingness of foreigners to hold IOUs denominated in U.S. dollars, such as U.S. Treasury bills and notes. Social Security.
Are you worried, too?
Our special report.



Buffett's approach is data-lite, but the data he does cite agree with the details of Greenspan's picture. Last year, we purchased $618 billion more in goods and services from the rest of the world than we sold. To pay for this current consumption, we're selling off our accumulated national wealth to the rest of the world at a rate of $1.8 billion a day. "Consequently, other countries and their citizens now own a net of about $3 trillion of the U.S.," Buffett wrote to his shareholders recently. Our overseas borrowing to fund the current account deficit is equivalent, he notes, to a family that sells off "part of its farm every day in order to finance its overconsumption."

Same data, different conclusions
What’s so striking is that from this remarkably similar picture of the current situation, Greenspan and Buffett reach almost diametrically opposed conclusions.

To Greenspan, it's no biggie. Even though we're running that huge trade deficit, the dollar's real exchange value, despite its recent decline, remains above its 1995 low, he told the Council on Foreign Relations. Interest rates on Treasury notes maturing 10 years in the future remain very low, despite the size of the federal deficit and the huge retirement obligations we're putting on the books. And there's no evidence that households are facing "inordinate financial pressures as a consequence of record-high levels of household debt relative to income."

The United States, Greenspan notes, almost with surprise, "appears to have been pressing a number of historic limits in recent years without experiencing the types of financial disruption that almost surely would have arisen in decades past."

Buffett, on the other hand, believes that we're headed for real trouble. "A country that is now aspiring to an 'Ownership Society' will not find happiness in -- and I'll use hyperbole for emphasis -- a 'Sharecropper's Society.' But that's precisely where our trade policies, supported by Republicans and Democrats alike, are taking us."

Buffet sees dire consequences
Buffett isn't forecasting economic collapse because he believes that foreigners will continue to lend to us: Foreign investors, he wrote in his letter to shareholders, "may view us as spending junkies, but they know we are rich junkies, as well."

But the consequences are still dire, Buffett believes. If current trends continue, a decade from now, just at the time when we'll need every dollar to pay for the retirement benefits of baby boomers, the United States will be sending 3% of its current annual output to the rest of the world as interest on the debt run up by its past consumption.

That royalty would run forever, unless we export more and consume less. And given the way global trade policies work, Buffett concludes, massively expanding U.S. exports isn't likely. Hence paying off this royalty would require a huge decline in U.S. consumption, Buffett says, with all sorts of nasty consequences for the global economy and the lives of U.S. workers and retirees. Don't pay it off and the already-projected squeeze on such frills as health care and education spending just gets worse.

Greenspan: The landing is soft
Don't worry, Greenspan says. We're headed for a soft landing. Foreigners will continue to send us their savings without demanding a huge increase in U.S. interest rates. Market forces --a fall in the price of the dollar and a consequent rise in U.S. exports and a drop in imports -- will gradually defuse the potential bomb represented by the huge increase in the U.S. trade deficit.

What's his logic?

Because the federal budget deficit, the run-up in consumer debt, projections of huge future retirement liabilities and the buildup in the trade deficit haven't resulted in the expected crisis to date -- and, in fact, haven't even produced the big projected hike in U.S. interest rates or a crash in the dollar -- something must be different this time. "Has something fundamental happened to the U.S. economy that enables us to disregard all the time-test criteria for assessing when economic imbalances become worrisome?" Greenspan asks.

Answering his own question, it's the increasing globalization of capital markets that has made all the difference. What Greenspan calls the "home bias" that kept investor's money in their national financial markets has eased so that investors seeking higher returns or diversification have sent more of their savings overseas. And the United States has been the prime beneficiary of that trend. (As you'd expect from Greenspan, he has data to support his belief in a decline in home bias: One measure of the propensity to invest at home for the developed countries representing four-fifths of world GDP has declined to 0.8 in 2003 from 0.97 in 1990.)

My problems with Greenspan's theories
I've got two problems with Greenspan's formulation. First, as Greenspan admits, a change in home bias doesn't solve the U.S. current account deficit; it just delays the reckoning. But since economists don't really know -- and can't reliably project -- the lag between trade deficits and deficit corrections, we don't really have any idea whether we are currently just in the lag period for a business-as-usual correction of the trade deficit or whether we've entered some unspecified lag period created by Greenspan's increasingly global financial markets.

It's an interesting theory. But as a guide to investing strategies, it leaves me completely without a road map or timeline.

Second, we've been down this "it's different this time" path with the Fed chairman before. Sometime after his more famous remarks about the irrational exuberance of the stock market, Greenspan became an apologist for higher valuations by citing the extraordinary productivity gains in the U.S. economy in the late 1990s. Historical measures of danger weren't valid for the then-current situation because the U.S. economy was growing so much faster than it had in other periods. Frankly, having bought into the first "it's different this time" argument to my pain and chagrin, I'm reluctant to buy into this new version.

The rate of capital-markets globalization remains vague. And while we know there must be some point at which foreigners will stop putting money into U.S. dollar-denominated investments, home bias or no, we have no idea where that point might be.

I've also paid attention to Greenspan's recent characterization of the problems of using productivity growth as a guide to policy. If you change "productivity" to "financial globalization," they're a warning to anyone who wants to use the newest version of "it's different this time" financial globalization to guide policy in the current global economy. "Productivity is notoriously difficult to predict . . . We have scant ability to infer the pace at which such (productivity) gains will pay out and, therefore, their implications for the growth of productivity over the longer run."

A bet that globalization of the financial markets will give the capital markets time to engineer a soft landing is a bet on faith in the powers of omniscience of the Fed. That may be good enough for Congress, these days, but it doesn't hold much appeal to me.

No, my money’s on Buffett. He's not asking me to believe it will be different this time. Again. And he has actually put $21.4 billion of his company's money in foreign exchange contracts that will pay off only if the dollar declines.

Next column: If you think Buffett's correct, or more nearly correct, what do you do?
 
millermandil said:
Hi There. Could someone please explain to me the mechanics of 'one currency being stronger/weaker compared to another currency/ other currencies' and what impact does this have on the stock market internationally? Im learning about the US Commodities market, so if possible, specifically in relation to the latter.

Furthermore, how does a currency become weaker/stronger...GDP?, economic growth?, interest rates? Employment?...

Thanks.
You have just asked a question as big as life itself.

However, since you appear to live in UK and have expressed an interest in
US Commodities, you are assuming a double risk.
Firstly, the commodity and secondly the currency.
You could be right and yet still lose money.
For example, let us say Greenspan raises rates next week ... not 0.25, as the last 6
hikes, but something substantial.
By doing this he is trying to attract buyers back to USD.
But let us say that Tokyo & Beijieng use this as a cover to sell $.
Nett result, G has expended valuable ammuntion for a nil result.
Who is G hanging out to dry .. simple. the overpriced, overleveraged house market.
Where do you put excess liquidity ... simple ...start a war
Why are commodities still bullish when the major markets are in deeper trouble than
they care to let on ...simple... the big coms traders are trying to cover their positions.

What does all this mean.

Be careful, be so very careful.
Find a trading style that suits you and stick to it
So sorry I could´nt give you a rational answer ... it is just that none of us have been here before
 
Hi,

Us is still reserve currency of the world, Only venezuela sells oil in Eur. Sadam Hussien did it, and the US switched it back to USD almost asoon as they occupied Iraq.

Most international debt is USD denominated.

For the above two reasons rich people will prefer some US bonds in thier asset base. Cos they know when it maturs the money will buy oil.

Loan repayment and interest repayment will be in USD so people will want to convert some of thier income and savings to usd to ensure they can make the payments.

These two needs become acutue in times of economic recession like we are starting to see. This will drive the USD to strengthen. As fed raises rates, The Boe wil be foreced to keep uk rates 1.5 to 2 % above. This is a historical fundamental for the above reasons. YES the medai is programming us all to thinks rates are comming down but they will be going up to portect sterling collapse.

The media was overly bearish on US to get us lot to sell it to the rich.

Time will tell.

We'll return to this thred in 12 months time

sp1
 
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