With many of the questions much of the headlines are posing along with questions we are receiving from investors, we felt it timely to post a multipart series on the US dollar.
In order to keep this simple, it can get complex very quickly, we are going to focus on the main reasons for currency movement, in our opinion.
Currency fluctuations, in our opinion, are the result of interest rates. Interest rates are not the only determinate, but, in our opinion, interest rates drive the majority of the currency movement.
Interest rates, compared to other world interest rates, are one of the main drivers for currency fluctuation. (The carry trade, a topic for another discussion, creates much of the currency movement, again, in our opinion.)
Ok, so assuming you agree with the interest rate discussion, let’s compare the goals of two monetary governing bodies, EU and US.
From the Bank of England’s Website, it’s two core purposes: http://www.bankofengland.co.uk/about/corepurposes/index.htm
“Core Purposes – Monetary Stability: Price stability and monetary policy
The first objective of any central bank is to safeguard the value of the currency in terms of what it will purchase at home and in terms of other currencies. Monetary policy is directed to achieving this objective and to providing a framework for non-inflationary economic growth. As in most other developed countries, monetary policy operates in the UK mainly through influencing the price of money, in other words the interest rate.
The Bank’s price stability objective is made explicit in the present monetary policy framework. It has two main elements: an annual inflation target set each year by the Government and a commitment to an open and accountable policy-making regime.
Setting monetary policy – deciding on the level of short-term interest rates necessary to meet the Government’s inflation target – is the responsibility of the Bank. In May 1997 the Government gave the Bank operational independence to set monetary policy by deciding the short-term level of interest rates to meet the Government’s stated inflation target – currently 2%
Core Purposes – Financial Stability
The Bank of England has played a key role in maintaining the stability of the United Kingdom’s financial system for 300 years and it is now a core function of most central banks. A sound and stable financial system is important in its own right and vital to the efficient conduct of monetary policy.
Since 1997, the Bank of England has had responsibility for the stability of the financial system as a whole, while the Financial Services Authority (FSA) supervises individual banks and other financial organisations including recognised financial exchanges such as the London Stock Exchange.”
Now, from the U.S. FOMC website: http://www.federalreserve.gov/pf/pf.htm
As you can see there are a distinct difference in policy from the two governments, leading to dramatically different interest rate decisions.
Greater interest rate discussion in next part of the series.
JK
John Kvale
Donald Capone
U.S Dollar, Down and Out, or Not to Worry? (Final in a Series)
If you agree, as we do, that current prevailing rates are a major factor in the value of a currency against its world peers, then as we stated in our first post, U.S. Dollar, Down and Out, or Not to Worry? (Part Two of A Series) different country mandates will have a major effect on the value of the currency. As countries begin to raise rates, again in our opinion, all other factors being equal the value of the currency will begin to rise against its peers, U.S. Dollar, Down and Out, or Not to Worry? (Part One of A Series).
Timing, most certainly will be different for different countries. Using the U.S. as an example, the recession has been hard and the government’s mandate may lead it to keep rates lower, longer, in order to stimulate growth, having an unintended consequence of the U.S. currency losing value against other countries as they raise their rates earlier in the economic cycle, see Australia’s surprise rate increase, and note the currency change http://www.marketwatch.com/story/australia-surprises-with-025-point-rate-increase-2009-10-05.
In a final “crisis related” thought, since we have a nice immediate historical review, the U.S., a large, well populated, growing country, that has established its self as a very strong World power. On a side note, see chart below, the currency of safety during the crisis; note how the U.S. Dollar rose extremely during a time of crisis, again in our opinion, showing it is the safe haven for today.
But what about longer term?
As Emerging and Developing countries gain footing in the world economy, and as the U.S. continues to age, it is not too hard to imagine a time where the U.S. will not be as dominate of a power as it is today. Power, for trading partners, lies with consumption and growth; therefore indirectly their currency. As the World gets smaller, and countries more equal, many currency safe havens and anchors may exist, for now, the U.S. Dollar seems to be acting in a more normal “prevailing interest rate” manner, again in our opinion.
Have a Good Day!
JK
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Posted in Economy, Interest Rates, Market Comments
Tagged US Dollar, US Economy