Archive for the ‘Currencies’ Category

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China is being accused of starting a new currency war. The People’s Bank of China has devalued the Chinese currency three times in three days. Politicians on Capitol Hill can barely conceal their ire. There is even talk that both the Fed and Bank of England will hike interest rates as a result. Yet for all that, it may simply be that China is doing what both the IMF and Washington have been calling for it to do for years.

China wants its currency, the yuan, or the renminbi, to be part of the basket of currencies that make-up the IMF’s Special Drawing Rights, or SDR.  For this to happen, the IMF says that the yuan must be allowed to trade freely on the open markets. China say that this is precisely what it is doing.

There was a time when China manipulated its currency, keeping its value artificially low. To achieve this, the government went out and bought western bonds, especially US government bonds. This in turn pushed up on the value of those bonds, causing their yields to fall. It’s an important point that often gets overlooked. Some criticise the Fed’s polices over the years, but truth be told in the long term, it is not central banks which determine interest rates, but movements of money which in turn can be changed by deep forces at play.  China’s policy of maintaining a cheap currency was a major factor in creating low interest rates for much of this century. And while the cheap yuan theoretically led to lower US exports, US borrowing was partly funded by China, and at exceptionally low interest rates.

It is just that the yuan is no longer cheap.  It hasn’t been for some time. If the yuan really was allowed to trade freely, it would surely fall in value. Washington can scream with fury, but China is gradually moving towards a position that the US has wanted it to occupy for years.

After the first devaluation, the IMF said “The new mechanism for determining the central parity of the Renminbi announced by the PBC appears a welcome step as it should allow market forces to have a greater role in determining the exchange rate. The exact impact will depend on how the new mechanism is implemented in practice. Greater exchange rate flexibility is important for China as it strives to give market-forces a decisive role in the economy and is rapidly integrating into global financial markets. We believe that China can, and should, aim to achieve an effectively floating exchange rate system within two to three years. Regarding the ongoing review of the IMF’s SDR basket, the announced change has no direct implications for the criteria used in determining the composition of the basket. Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the Renminbi were included in the currency basket going forward.”

Some say the timing is cynical, because China has devalued in the same week that saw weak data on industrial production investment and retail sales. That may be right, but so what. China is simply doing what the IMF has recommended, but chosen the most fortuitous moment. What’s wrong with that?

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The pound fell to a three year low against the dollar last week, and predictions of doom emanated from the UK’s more cynical press. ‘Oil will go,’ they cried, ‘the cost of holidaying abroad will shoot up,’ they moaned, ‘oh woe is us,’ they lamented. There are indeed strong disadvantages to having a cheaper currency. But there are advantages too, and there are reasons to think that the pound may fall a lot further yet – at least relative to the dollar.

There is one thing that Mark Carney, the Bank of England’s new governor, and Haruhiko Kuroda, the newish governor of the Bank of Japan, have a lot in common. Actually they probably have a lot in common but let’s just focus on this one obvious point today. They both seem to be in the process of enacting policies to weaken their respective currencies. In Japan where the governor has been in his post for a few months longer, the policy is advanced; in the UK it is only really being hinted at.

But recently Mark Carney made it just about as clear as was possible. Even if the Fed starts to tighten monetary policy sooner rather than later, and the dollar rises as a result, putting the pound under pressure, the Bank of England will not necessarily follow suit.

The pound fell sharply on the news. At one point last week there were less than 1.49 dollars to the pound. That was a three year low. But then Fed chairman Ben Bernanke appeared to do something of a backtrack, and the pound rose back up, finishing last week with an exchange rate of 1.51, which actually was nothing out of the ordinary – not over the last year or so, anyway.

It may be worth making a few comments at this point. Firstly, the Fed’s attempt to clarify last week, and reassure us about monetary policy was about as unambiguous as a disco dancing sloth. Frankly, Bernanke didn’t really appear to say anything new, and it is clear that opinion is divided amongst his colleagues at the Fed. The timetable for the Fed tightening its policy – namely reducing QE later this year, removing it altogether next and upping rates in 2015 – seems to be unchanged. But because Ben used some nice reassuring words, the markets seemed to love his comments. Equities lifted, pushing the Dow and S&P 500 to new all-time highs and alleviating pressure on the pound, as they somehow concluded that there was something new in the Fed’s words and that monetary policy will not be tightened as quickly, after all.

Secondly, the pound may have fallen against the dollar, but the UK press missed the wider story. This was not so much a case of a falling pound as a rising dollar. The euro pound exchange rate has done nothing spectacular. However, look deeper, and it appears there are reasons to expect sterling to fall.

For one thing, a comparison of UK unit labour costs with the rest of the world suggests sterling is overvalued. The real effective exchange rate (based on IMF data) is 7 per cent above the level seen in the mid-1990s and 20 per cent above the level in the mid-1970s, or so says Capital Economics.

For another thing, something a little disturbing has happened to the UK’s balance of payments. We are used to seeing a deficit on trade in goods and services, but at least income from investments flowing into the UK tends to be greater than income flowing abroad. But there are signs that this is changing. The UK’s net investment income has been negative in three out of the last four quarters. The story here is complicated. The value of investments held by foreigners, but relating to the UK, is much greater than British investments abroad. But UK investments held abroad tend to be higher risk, and generally provide a much higher return. There are signs that this is changing, however, and that is a worrying development. To be clear, if net investment income continues to be negative this will put pressure on sterling relative to most foreign currencies, not just the dollar.

While is it the case that the real currency story of the last few weeks has been one of the dollar versus the rest of the world, across much of the global economy central banks have responded by upping interest rates themselves. For example, they rose last week in Brazil. China’s central bank is tightening, and rates were recently increased in Indonesia. The story is not clear cut – these things never are, but as rates rise in the US, leading to a stronger dollar, many other countries will probably follow suit. If the UK and Japan loosen monetary policy at such a time, they will be in the minority putting both the yen and sterling under pressure against a basket of international currencies – not just the dollar.

On the other hand, the prospects for the UK economy have been improving of late, and it would be odd if sterling tumbled just as UK plc began to show signs of pulling out of its downturn.

But supposing it happens and the pound falls much further, what then?

At a time when there are signs of improving exports, especially to the US and outside Europe; at a time when some anecdotal and some hard evidence (see car exports) points to a mini renaissance in the UK manufacturing industry and its exports, a cheaper pound will give exporters even more of a lift. On the other hand, a falling pound may lead to rising inflation, and in this respect the UK has previous. Think of 1967 and the pound being devalued and the then Prime Minister Harold Wilson saying it will “not affect the pound in your pocket.” In fact sterling’s devaluation did – UK inflation shot up soon afterwards.

And that brings us to the UK’s big dilemma.

Yes we need exports to help lead recovery, but we also need increases in average wages to start outstripping inflation again. A cheaper pound may help us achieve the former, but most certainly not the latter.

What the UK really needs is productivity to rise, and that needs more investment; more investment in business, in entrepreneurs, infrastructure and education – and, it may seem like a cliché, investment in education in creating more engineers, because that is where the real labour market shortage is likely to be.

There is a danger, however, and to read about that, see  What will happen to households as rates rise? 

© Investment & Business News 2013

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The pound fell to a three year low against the dollar this week. At the time of writing there are 1.4949 dollars to the pound, and many have hit the panic button. They say a crash in sterling is in sight. Are they right?

The current dollar pound exchange rate is low, but it’s far from being a record. It was lower in 2009, and in the mid-1980s went close to parity with the dollar. There are two reasons to fear for sterling, and indeed the consequences of a fall in the pound. But there are reasons for less pessimism, indeed even optimism too.

Reason number one is the Fed. If good news on the US economy continues it has said it will start cutting back on its quantitative easing programme this year, halt it altogether next year, and up interest rates in 2015. If this is indeed how it pans out, as US rates rise, money might well flow into the US from the rest of the world. Many central banks may respond by upping rates.

Because of the high level of household debt we can’t really afford higher interest rates in the UK. The Bank of England may have to choose between upping rates to stop a rout on sterling, but creating massive hardship for households with high debts in the process, or just accept a much cheaper pound relative to the dollar. Just bear in mind, however, that this problem is not unique to the UK, and if rates rise in the US, the pound may fall relative to the dollar, but stay firm relative to other currencies, such as the euro.

Reason number two is more serious. In the UK we are used to imports of goods and services being greater than exports, but at least income from investments flowing into the UK tends to be greater than income flowing abroad. But there are signs that this is changing. The UK’s net investment income has been negative in three out of the last four quarters. The story here is complicated.

The value of investments held by foreigners but relating to the UK is much greater than British investments abroad. But UK investments held abroad tend to be higher risk, and generally provide a much higher return; there are signs this is changing, however, and that is a worrying development.

To be clear, if net investment income continues to be negative this will put pressure on sterling relative to most foreign currencies, not just the dollar. On the other hand, a cheap pound may be good for exporters, although it will be bad for inflation, and may extend the period of time in which wage increases lag behind inflation.
But this may not occur, not at all.

Take the latest trade data. In the latest three months the value of exports to China was 17 per cent per cent higher than the average 2012 quarterly level. Import values from China were little changed, so the trade deficit with China, which had averaged £5.2 billion a quarter in 2012 shrank to £4.8 billion in the last three months.

Historically, the UK runs a trade in goods surplus with the United States. That rose in the latest three months. The value of exports was 5 per cent higher than its average 2012 level, while imports fell by 8 per cent. In the three months to the end of May, exports to non-EU countries increased by £1.7 billion while imports increased by £0.9 billion.

There is another reason for optimism, there signs that the UK is on the march to recovery. See: UK recovery: the reasons why and why not 

There is one big danger however. The UK does suffer from a disease. For too long money has flowed into supporting the housing market – though not house building – but there are few signs this is changing.

Remember, the strength of sterling tends to tell us how strong the economy is. If the economy does well sterling usually rises. In a way, the value of the pound is like the UK’s share price.

Right now, company cash holdings sit at around 20 per cent of GDP or at a 25 year high. If this money is used to fund investment, then the UK may boom. If instead, companies hoard their cash, banks focus on parking cash sitting in deposit accounts in mortgages, and the government focuses on trying to get house prices rather than investment up, the UK’s share price – or if you prefer to put it these terms, the value of the pound – will come under new and prolonged pressure.

© Investment & Business News 2013

The US consumer is paying back debt. Within a couple of years, this little critter may once again be the lynch pin of global economic growth. But if US consumers return to normal, does that not mean US interest rates will do so too?

The Fed has already dropped hints about the imminent end of QE. Although frankly it may not be until next year that we see it come to a complete end, and interest rates of 5 per cent are surely at least two years off, maybe a good deal longer.

But the markets are already pricing in the changes.

You may recall that two or so years ago, the Brazilian finance minister accused the US of engaging in currency wars. He said that QE was forcing the dollar down, making the Brazilian real less competitive. By the end of last year and early this year, we heard less about that, because rising inflation in Brazil meant that it rather suited the country to have a relatively expensive currency.

But the Fed is no longer the demon that is using artificial means to devalue the dollar; now it is the demon that is dropping hints about ending QE. You can almost hear the rate setting committee’s maniacal laughter emerging from the catacombs of the Fed, like the evil villain in a Hammer horror movie – at least that is how some might interpret it.

Writing in the ‘Telegraph’, Ambrose Evans Pritchard suggested that Brazil may not even have enough reserves to stop recent falls in the real becoming a rout. Brazil has scrapped a financial transaction tax on foreign investors, and upped interest rates. The markets are rattled. The markets are pricing in further hikes in interest rates. But growth in Brazil is falling. It’s not a good combination – rising rates at a time when growth is anaemic

Neil Shearing, chief emerging markets economist at Capital Economics, said: “Not only is growth likely to remain weak, but food inflation also looks set to fall sharply over the second half of the year. This alone could knock up to 1.5 per cent – points off headline inflation.” He said: “We are sticking to our view that this will be the shortest tightening cycle in Brazil’s modern history.”

But currencies have fallen across much of the emerging world. The South African rand has taken a beating, and Indonesia’s central bank surprised markets by increasing interest rates.

We appear to be entering an era in which good news out of the US is leading to speculation that US monetary policy will be tightened faster than the Fed has suggested. This in turn is creating a stronger dollar, and putting emerging markets’ currencies under pressure leading to higher interest rates, and speculation that they will rise further.

Good news in the US has started it all, but one side effect has been panic.

© Investment & Business News 2013

10CC had the right sentiments; you just need to swap the word cricket for QE. “I don’t like QE, oh no, I love it”, or so they might have sung. “I was walking down the street,” said the Brazilian Finance Minister, “I heard this dark voice behind me, and I looked around in a state of fright…” But when he turned around he did not see “four faces, one mad; a brother from the gutter”, instead he saw Ben Bernanke and Mervyn King: “They turned to each other.”

“They looked him up and down and”, alas, that is where the rhyme stops. “We need quantitative easing, man,” they said. And they then did, they made it, money from the gutter flowed across the world.

The Brazilian Finance Minister called foul; he called it a currency war.

It is not like that now. As the Fed hints that QE may be coming to an end, as good news on the US and UK economy erupts from the bellies of Purchasing Managers Indices, markets fear what will happen if the era of cheap money, or magic money created from the dust, comes to an end.

The FT quoted Marcelo Salomon, an economist at Barclays, who said, “The [Brazilian] government is getting concerned that global liquidity conditions are changing really fast and that this could push the real to a much weaker level.”

So what to do? First off, Brazil has cut its equivalent of a financial transactions tax, which is to say its tax on overseas investment and which is called IOF, from 6 per cent to zero.

Brazil’s Finance Minister, Guido Mantega said, “With the market normalising and the movement of the [US] Federal Reserve to reduce its expansionist policies, we were able to remove this barrier.” But the FT sees the move as more dramatic than that and said that the Brazilian government feared a weakening currency could spark off inflation.

Indeed,  US QE may have been good for Brazil because it kept Brazilian inflation in check.  For that matter, in as much as QE led to higher commodity prices, and Brazil exports commodities, QE may have been very good for Brazil.

Maybe it is time Brazil’s Finance Minister comes clean by admitting, “I don’t like QE, oh no, I love it.”

© Investment & Business News 2013

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Who needs central bankers anyway? It’s a view often expressed by the more adamant supporters of the markets.

This is what Nassim Taleb had to say on this very matter in his book ‘Anti Fragile’: “Ask a US citizen if some semi-anti governmental agency with a great deal of independence (and no interference from Congress) should control the price of cars, morning newspapers and Malbec wine….He would jump in anger as it appears to violate every principle the country stands for, and call you a communist post-Soviet mole for even suggesting it. Then ask him if the same government agency should control foreign exchange, mainly the rate of the dollar against the euro and the Mongolian tugrit. Same reaction: this is not France.

Then very gently point out to him the Federal Reserve bank of the US is in the business of controlling and managing the price of another good , another price called the lending rate, the interest rate in the economy (and has proved to be good at it). The libertarian presidential candidate Ron Paul was called a crank for suggesting the abolition of the Federal Reserve or even restricting its role. But he would he also have been called a crank for suggesting the creation of the agency to control other prices.”

Losing candidate for Vice President at last year’s US election Paul Ryan is also an arch critic of central banks, and about as anti QE as you can get.

Now enter stage right a new currency. It’s called the Bitcoin, and was launched in 2009 by a developer with the pseudonym Satoshi Nakamoto. It’s a virtual coin, existing solely on the Internet. You can buy goods and services in Bitcoins, and your store of Bitcoin wealth exists in a kind of virtual wallet.

Although the Bitcoin may not have been designed specifically for this purpose, it is often used to purchase illegal goods.

The supply of Bitcoins – if you like the money supply – is controlled by algorithms. There is no central bank; instead a peer to peer network controls this currency via the forces of the market. At the beginning of this month the monetary base was said to be around $1 billion.
So this is an experiment in libertarian economics. Will this new fiat currency replace those that are artificially controlled by central banks?

There is a snag. And the snag comes in the guise of a bubble. The price of a Bitcoin – or if you like, its exchange rate – has doubled in two weeks and, according to the ‘FT’, the monetary base is now worth $1.5 billion.

UBS stockbroker Art Cashin said in a note to clients: “Trading tulips in real time…It is rare that we get to see a bubble-like phenomenon trade tick for tick, but all that may be changing before our very eyes.”

The Cypriot crisis has not helped, with the currency’s supporters describing it as an alternative to conventional currencies.
But is the rate at which is value is soaring sustainable? Probably not. Is it a bubble: probably.

But the question is: does it matter?

In a world of no central banks, and currencies that are solely controlled by markets, failure is essential for correcting errors and for punishing over-exuberance. According to libertarian economics, market forces ensure recessions are only ever short lived affairs.

But are the libertarians right? Perhaps they are, but just remember that in nature – that ultimate example of a free market – growth is not automatic; change often only occurs after some kind of natural disaster, and sometimes evolution can throw up inefficient quirks such as peacocks, whose colourful appearance makes the male attractive to potential mates, but easy prey.

©2013 Investment and Business News.

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The evidence is growing.

Take the IMF, for example. According to its latest report on currency reserves, developing countries rid themselves of $45 billion worth of dollars last year. Since Q2 2011 they have sold $90 billion dollars. Over the same period, the developed world has been a net buyer of dollars, and in 2012 was even a net buyer of sterling.

See: Currency Composition of Official Foreign Exchange Reserves (COFER)

Meanwhile, Bloomberg quoted Hans- Guenter Redeker, the head of global currency strategy at Morgan Stanley, who has predicted that within two and half years the euro will be back to parity with the dollar. Capital Economics cited data from the US Commodity Futures Trading Commission which showed that speculative “long futures positions against the euro, sterling and yen combined have topped 200,000 for the first time since last May and are not far off a record high.”

So what’s next? The recent movements in favour of the dollar can’t go on without interruption. Capital Economics predicts some kind of correction in the next few months, but says that looking further ahead to the end of this year and beyond, the dollar is likely to rise further against the euro.

No prizes for guessing why. Following the Cypriot debacle, there is now speculation that Slovenia will be the next Eurozone country to suffer a crisis, and the markets have become scared of the Eurozone. There is a good reason for this. But what about the yen and the good old pound? Central banks in the UK and Japan are expected to hit the QE button hard this year. But so what? Japan’s prime minister and arch dove Shinzo Abe has warned that achieving a 2 per cent inflation target in Japan may not prove possible.

There is an irony here. In the UK, the Bank of England has failed to get inflation even close to target. In Japan, the central bank may fail likewise but in the opposite direction. In Japan, the challenge is getting inflation up. Later this year, rises in commodity prices may lead to a temporary lift in Japanese inflation, but it is far from certain that this will last, and the central bank may yet prove to be impotent.

In the UK we have had £375 billion of QE so far, and while the initial burst may have kicked some life into the economy, subsequent rounds have done very little. The truth is that at a time when banks are being forced to raise capital levels, and the government is afraid to borrow the money, the markets want to lend to it at such cheap rates, QE is about as effective as a leadless pencil. In short, the Bank of England may be impotent too.

For that reason, Capital Economics reckons that while the dollar may well rise against the euro, against the yen and sterling it thinks the rises against the US currency are behind us. Against the euro, of course, it is a different story.

©2013 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here