October 2007

Vol 7 - No. 4
 

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Economy | October 2007

 


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The Fall of the Mighty U.S. Dollar 
Hits lows against major currencies
 

On September 20, in New York, the US dollar dropped in against European Euro – to a record low through the $1.40 level – as the dollar continued its skid on the heels of the U.S. Federal Reserve’s decision to cut interest rates by half a percentage point on September 18.  

The recent depreciation of US dollar has created quite a stir in the countries throughout the world. All the economies trading largely in US dollar have some impact on their present working. But what is more of an alarming question is that - is the US Dollar depreciation a well planned initiative by the world wide central bankers or are we going to witness an uncontrolled collapse of US Dollar?

The US Dollar Index fell well below critical support levels — to within a fraction of a point of its lowest level in history.

Investors are shunning U.S. Bonds. The U.S. Treasury reported that purchases of U.S. bonds collapsed from $97 billion to just $19 billion in July alone. Overall, more U.S. Treasuries were sold by global investors than are being bought in July.  

Traders told the FT that the euro’s rise through the psychologically important $1.40 level – a “pain barrier” for eurozone exporters – triggered a surge in stop-loss buying, shooting the euro even higher. The euro rose 0.8% to $1.4071 against the dollar. The dollar fell 0.4% to $2.0093 against the British pound Sterling, skidded 1.5% against the yen to Y114.44, and fell 1% to SFr1.1717 against the Swiss franc, the FT said.

Some analysts put the dollar’s weakness down to speculation that Saudi Arabia was set to abandon its peg against the US dollar.

The talk was started after the Saudi Arabian Monetary Authority announced that it was not going to follow the Fed and cut interest rates in spite of the Saudi riyal’s link to the dollar.

Hans Redeker, of BNP Paribas, said Saudi Arabia not following the Fed’s lead was understandable given the rising inflationary pressure within its economy. “The currency peg will come under increasing pressure the more economic fundamentals of the region diverge from the recessionary US environment,” he said. Marc Chandler at Brown Brothers Harriman said the dollar’s fall was a reflection of negative sentiment towards the dollar, and talk that Saudi Arabia would abandon its link to the US currency was wide of the mark. The SAMA had subsequently announced that it held rates steady to combat domestic inflation, he said.

“SAMA did not follow the Fed with a rate hike last year and has repeatedly indicated it will not abandon the peg.”

Until now, Saudi Arabia’s currency — the riyal — was pegged to the value of the dollar. That meant every time our Federal Reserve cut interest rates, the Saudis cut their interest rates, too. And when the Fed inflated US Dollar, the Saudis had no choice but to inflate theirs as well.

But now, the Saudi money supply is exploding 22% per year and inflation is roaring at 4% per year. So its government is refusing to make matters worse by lowering interest rates, and top Middle East analysts are warning that the Saudis have taken the first step towards unpegging their currency from the dollar.

That would be disastrous — especially if it triggers a stampede away from the dollar throughout the region — because these countries now control more than 3.5 trillion U.S. dollars.  Once their currencies are no longer tied to the dollar, they’re likely to start dumping a big chunk of that $3.5 trillion to protect themselves from the big losses that automatically come with a sinking greenback.Bad news for the dollar is pouring in so fast, it’s nearly impossible to keep track of it all ...International Investors Are Abandoning the Dollar, Driving It Toward  All-Time Lows .

Saudi Arabia is the big man on campus in the Gulf. And historically, it's been a strong U.S. ally. If it decided it no longer needed the dollar, many other oil-producing nations might reach the same conclusion. In fact, Kuwait already broke its dollar peg in May. And the United Arab Emirates could break off its dollar peg in the near future.     [Source: Agencies]

Canadian Dollar Surpasses US Dollar

For the first time since November, 1976, supported by surging oil prices and broad weakness in the greenback, the Canadian dollar pulled even with its American counterpart. Shortly after eleven o'clock in the morning on September 20 the loonie hit par with the U.S. greenback. Only five years ago, it bottomed out at 62 U.S. cents, but has been on a spectacular run for the past few weeks, gaining about five full cents since the start of the month.

The Canadian dollar surged 1.4% C$1.0012 against the U.S. dollar. 

RBC Capital Markets analyst Adam Cole told Financial Times (FT) that he expects the Canadian dollar to continue its upward trajectory. The reason: “Canada produces the commodities the world wants – it is still the number one commodity play among major currencies.” Cole said.  

What’s more, Cole said, the Bank of Canada is welcoming the currency’s strength. Prevented from boosting interest rates by the global credit crunch, the rise of the Canadian dollar has helped that nation’s central bank in its battle against inflationary pressures.   

Through most of 1970 and 1971 it was very close to the U.S., and on April 25 1974 reached a high of US$1.0443. This was a time when the Canadian dollar was strong against a weakening U.S. currency.

By the end of 1979, the Canadian dollar closed at US$0.86. The gradual, but sustained decline in the value of the Canadian dollar, continued through 1993 and 1994. Another low-point came in 1998, after a year of turmoil in international markets, with the loonie at US$0.6311 on Aug. 27. People started making jokes about the "Canadian peso.'    [Source: Agencies]

Financial Post's Paul Vieira:

Jim Flaherty was a young trial lawyer, earning roughly $15,000 a year, the last time he was able to trade a Canadian dollar straight up for U.S. buck. That was 31 years ago. Now he's the Minister of Finance, arguably the most important mover and shaker in Canada's capital markets. He will go down in history books as the Finance Minister in charge when the Canadian dollar regained its parity status with the United States. While some may choose to celebrate, Mr. Flaherty is treating it matter-of-factly. If anything, he is cautious and expressing concern about the weakness of the U.S. economy -- which was a key factor in driving the loonie to US$1. 

Interview with Jim Flaherty

There is obviously weakness in the U.S. economy, especially in the housing sector and in demand for autos. That affects consumer demand and that affects exports. So that is a concern.

But we are in the 16th year of sustained economic growth in Canada, the second longest in this country's history. We have the best job market in a generation. And Canadian corporate profits are at a record high and corporations are well-capitalized. And the profits here are well above their U.S. counterparts.

We are in a position of strength in Canada, not just on the private sector, but also in the governmental sector, where we have for the first time in 60 years every government in surplus. That is dramatically different than in the United States.

I am concerned about the weakness in the U.S. housing market. And I am concerned about U.S. auto demand. The Canadian dollar is a reflection of the strength of our economy, some weakness in the U.S. economy, and commodity prices as well.

I think we may see some impact that would be expected in the Canadian economy, but within our expectations. We have known for some time, and have repeatedly said, that one of the major risks and challenges we have as an economy is a slowdown in the United States and we are now seeing that.

    Express India Blog: 

Most countries like India have adopted a system of exchange rate whereby the rate is determined by demand and supply of currency but the central bank or the government intervenes from time to time and regulate the exchange rates to control its movement in any particular direction. Project India – a profitable venture With forex reserves of about US$ 214.835 billion, India is emerging as one of the fastest developing nations on the globe. Even its GDP has crossed the US$ 1 trillion mark…. 

The European Union is gaining strength at an extreme pace and the effect is Dollar losing grounds against Euros. Also, is the fast track development of the BRIC countries, whereby China and India to be emerging as fastest developing economies on the planet. With so much happening, it is clearly understood that much of international trade can happen with countries other than US, resulting which the mighty Dollar is no longer in much demand. Once the Asian or the exporting countries of the east understand the losing relevance of US Dollar, they will have an increased interest in switching of reserve assets out of Dollar. There are already instances where the OPEC countries have shown a greater interest for trading in Euros instead of Dollar. Even countries like Russia have put a leg forward for trade in Euros. With a fall in demand for the King Dollar in the international trade, that too for fossil fuel, the collapse of US Dollar can not be seen as a distant reality…. 

But now with the Dollar depreciating, we are (India is) suddenly witnessing the evaporation of our forex reserves. Not only India, but all export driven countries of the east are facing similar, or identical rather, crisis. But the more complex situation is that even as we know, as well as our counterparts in Asia and elsewhere are also aware of the situation that if one or more countries try to switch over their reserves in Euros or any other alternate currency, it will immediately bring down the value of US Dollar to drastic levels. So it would take real guts for any country to risk this stunt of switching out of the damn Dollar. Moreover, and most importantly, as the US Dollar depreciates vis-à-vis Rupee, the exporters are in a fix. Every exporter in India will start losing its competitiveness against its Asian counterparts. Also, there is good news attached with this. The importers in India will have a gala time as the costs of imports have come down due the fall in Dollar value. But besides the fall in exports and a rise in imports, there are other intricacies to be understood. It is a known fact that US is the largest consumer in the world. With the US Dollar depreciating, it becomes more difficult for the Americans to continue their huge consumption pattern by borrowing more money from rest of the world. 

So, gradually, the US will start declining their consumption as imports gets costlier. On one hand, this will lead to a further dip in US Dollar and on the other hand, the exporting countries will be stranded with huge unshipped stocks of a decreased value. On this side of the planet, we see the Rupee appreciating. In economic terms, it clearly means that the demand for Rupee is increasing, whereby it promises a better value and hence more investments of international nature are attracted into the country. When so much money is being pumped into the economy, naturally more money is in rotation and a simple law of economics tells us that more money in the economy will lead to a higher rate of inflation. Ofcourse inflation is a disease which the government keeps on fighting round the clock. But what surprisingly contradictory seems to appear here is whether the inflation rate will rise or fall. One theory we saw is the money supply thing where more inflow of money will lead to rise in inflation. 

But on the other part, when we consider the US Dollar declining, which means the imports getting cheaper. With cheaper imports, the money flowing out will be on a rise. Also, India imports more than three-fourth of its Fossil fuel requirement. With Dollar depreciating, the oil will become cheaper and as all the other commodity prices are linked with the price of oil, we may see a fall in inflation level. Amidst the brouhaha of the global imbalance, the million Dollar, or should we say the million Rupee question is should we hold on to the US Dollars in our forex reserves and watch it eroding day by day for should we hop onto Euros and witness a global collapse of US Dollar. As rightly quoted by a Chennai based Mr. M R Venkatesh, that the US Dollar that we are holding is nothing more that a promissory note of a defunct finance company. 

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