June 3, 2008

Dollar Alarm - The Currency Paradigm

This recent op-ed from the WSJ, presents a fine discussion of some of the issues facing G7 Central Banker’s, in the wake of turmoil in the world’s financial markets. In particular it focuses on US monetary policy, and its effects on other world currencies.

“Currencies are not a typical commodity, like wheat or platinum. They are a medium of exchange. While currencies are freely traded in a world of floating exchange rates, the supply of dollars, euros or yen is set by a cartel of central banks. Those banks can influence exchange rates by signaling a change in their respective monetary policies.”

I wonder if the author is aware that the phrase “cartel of central banks” is likely to be borrowed by all manner of “causes” as the underpinning of proof of some paranoid conspiracy, hatched in the nether regions of the web.

Seriously though, the limited supply of money, combined with relatively unlimited exchange of money, certainly differentiates fiat money from good ol’ fashioned bricks and mortar commodities.

“This is where the currency traders will test the G-7's sincerity. The hint that the countries might "cooperate" to influence exchange rates is a warning that central banks could intervene in currency markets and catch some traders on the wrong side of a bet. However, such interventions are typically "sterilized," which means that the banks quickly mop up whatever dollars or euros they use to intervene in markets. If central banks really want to put a floor under the buck, the Federal Reserve will have to change its weak-dollar policy.”’

Sterilized… indeed. That’s the straight-dope on Central Bank realpolitik courtesy of the Wall Street Journal, and your good friends at http://GlobalITandBusinessnews.blogspot.com.

“Dollar weakness has contributed to soaring commodity prices that have walloped U.S. consumers just when their spending is most needed to offset the housing slump. The commodity boom is the result in large part of the Fed's weak-dollar policy, and it may have tipped the U.S. into a recession that could have been avoided.”

“As Stanford's Ronald McKinnon noted on March 31 on these pages, the Fed's easing has also driven private capital away from the U.S. Money has flowed instead to those countries with rising currencies, such as China. To prevent the too-rapid revaluation of their currencies, these central banks are buying up dollars, which they then invest in safe U.S. Treasury’s. This explains the paradox of low U.S. Treasury rates even amid a weakening dollar.

Another thing that explains low US T-bill rates is that America’s exports are increasing quickly, as its current account deficit declines. The “paradox of thrift” this is not. http://en.wikipedia.org/wiki/Paradox_of_thrift

When you are the world’s reserve currency, the forces acting upon, and the momentum acting with the currency are unique. In a way, in its role as the reserve currency of choice, the USD dollar is the paradigm upon which all other currencies are built upon. As the star in a heliocentric currency solar system the fundamentals rules of financial gravity that may apply to all other currencies, may not always apply to the USD.

“In a double irony, China is now revaluing the yuan of its own accord to avoid importing inflation from the U.S. Other countries that have pegged their currencies to the greenback are now de-linking. The U.S. devaluationists are getting their way, but in the most painful way possible for the U.S. and world economy.”

Trader #1 – “So you work in International trade eh? What’s your poison?”

Trader #2 – “I export inflation”

Trader #1 – “Very cool, I hear that’s a growing market”…

Trader #2 – “Definitely, it’s an emerging one too”


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