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The coming dollar crisis

September 17th, 2005

Brad DeLong has a great discussion of the opposing views on the coming dollar crisis.

More soon on this, but my one-sentence take is that the optimists believe that it is possible to generate as much US dollar liquidity as required to prevent a large increase in interest rates (despite a depreciation), without generating domestic inflation in the US. In this, they have recent US history on their side. The pessimists think that, sooner or later, this kind of policy will fail. In this, they have long-term history on their side

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  1. September 17th, 2005 at 14:16 | #1

    I guess, the longer you say something, eventually it will happen, especially if its a 50-50 bet that the USD will trend up or trend down!

    The issue I have is accepting that the fundamentals are all true, and there will be a crisis of confidence in the USD forcing/propelling USD cashed up foreign investors to pull their USDs out of America, where on earth are they then going to put all that money.

    Capital always need a home.

    They can’t pump it into China (I’m just exploring alternate homes), given its lax corporate governance and other capital controls. Japan? probably not. So why not keep it in the US of A.

  2. Terje Petersen
    September 17th, 2005 at 15:56 | #2

    The fundamental task of monetary policy should be to maintain the currency at a stable value. How you measure value (grams of gold or baskets of groceries) is open to some debate but the basic concept should not be.

    The value of the US currency is determined by two factors. One is the demand for the currency. The other is the supply produced by the US Federal Reserve. They can print more currency and maintain stability of value only so long as demand is strong.

    One of the complexities for the US currency is that demand from abroad is a bigger component of the demand for their currency demand than for other nations. The US dollar remains the dominant currency for international trade and as an international reserve.

    To be sure the world needs a common currency (not a single currency). However I would prefer a common currency that was not beholden to one nation, institution or government. I think we would be better off if we went back to gold as the currency of international trade, and as the universal unit of account. This is in essence what the Malaysian government has been calling for over the last few years.

  3. Ian Gould
    September 17th, 2005 at 16:22 | #3

    Terje,

    Stable relative to what? In the real world the relative prices of different goods are always changing, based on all sorts of factors ranging from weather to fashion to technological change.

    You can also question whether it’s ever possible, or even desirable, to fix rates relative to other curriencies given factors such as differences in governance and economic growth rates.

  4. September 17th, 2005 at 18:47 | #4

    Mason Cooley said “Money comes to life as it is spent”. Unfortunately, for the Chinese, they are funding spending on a country of dubious credit-worthiness in the future.

  5. still working it out
    September 18th, 2005 at 00:20 | #5

    “forcing/propelling USD cashed up foreign investors to pull their USDs out of America, where on earth are they then going to put all that money.”

    They don’t need to pull their money out to initiate a crisis. As Brad Setser and Nouriel Roubini keep pointing out, all that needs to happen is for Asian nations to stop or mabe even just slow down the rate at which they are putting money into the US. If that happens the US Current Account Deficit will be unfunded and, if Roubini and Co. are correct, a crisis will have begun. Once a crisis of confidence in the USD is initiated money stored in USD liquid assets will be better off almost anywhere outside the US because money that is too slow to leave the America before the depreciation gets too big will already have lost some significant fraction of its value.

    Looking forward to Pr Q’s comments on this issue, particularly on the question of whether Australia will be sucked down with the USD. Our position is not all that much different. This looks like it may be the most significant problem facing us over the next few years. Its amazing that it does not get more focus.

  6. Terje Petersen
    September 18th, 2005 at 04:58 | #6

    Ian,

    Stable relative to what is an excellant question. I would say stable with reference to the centre of mass.

    If we visualise the value of things changing in relative terms we might see something that looks like a swarm of bees. Stability should be with reference to the centre of the swarm.

    Which bees to include in the swarm is the question. In Australia we use the CPI. It excludes all bees that live abroad. I disagree with that approach.

    We should have a single global “centre of swarm”. Just as NSW and Western Australia use the same reference point so should Australia and England. In an open global economy our local nominal prices should tell us where we are relative to the global trend.

    The best proxy for a global swarm is a global commodity, or a basket of commodities. I still think gold is the best proxy.

    Regards,
    Terje.

  7. Ian Gould
    September 18th, 2005 at 08:00 | #7

    >a crisis of confidence in the USD is initiated money stored in USD liquid assets will be better off almost anywhere outside the US because money that is too slow to leave the America before the depreciation gets too big will already have lost some significant fraction of its value.

    The US is starting to look more and more like south East Asia just before the 1997 crisis. Following up on your point regarding the need for the East Asian states to continue pumping in fresh money, several of those states are running big government deficits specifically because they’re buying huge volumes of T-bills.

    Taiwan is particularly worrying in this regard. any political or military crisis involving Taiwan and China may end up affecting the US in a much more direct and painful way that most observers currently realaise.

    >Looking forward to Pr Q’s comments on this issue, particularly on the question of whether Australia will be sucked down with the USD. Our position is not all that much different. This looks like it may be the most significant problem facing us over the next few years. Its amazing that it does not get more focus.

    As others have pointed out, the hot money will be looking for somewhere else to go if the US looks less attractive. Realistically, short of civil war in the US or the US Treasury repudiasting its foreign debt, the US is such a large part of the US debt market that fund managers will continue ot put a lot of money there.

    But a small shift in the volume could have a significant impact on otgnher countries such as Australia. And, of course, it only requries a small shift to alter the market price for debt dramatically.

  8. Joseph Clark
    September 18th, 2005 at 12:56 | #8

    Talk is cheap. If anybody is convinced of a big move in the Australian dollar they should take this to market. You can make an awful lot of money this way if you are right. Unless you’re not so sure after all…

  9. September 18th, 2005 at 15:00 | #9

    Actually, without a working gold standard in place, gold isn’t as good a proxy as some other things. It would actually be easier to move to a working silver standard than a gold one – but even a silver standard isn’t in place and would involve a serious transition.

    I believe the US removed silver sertificates from convertibility after they stopped making the US$ proper from being convertible to gold.

  10. Terje Petersen
    September 18th, 2005 at 21:04 | #10

    PML,

    I agree that gold is a more stable price reference when gold is the common unit of account. It better regulates its own production in that instance. However it is still broadly accurate even in the absence of that situation.

    The EU has what is called a HICP (Harmonised Index of Consumer Prices) with which the success of monetary policy is measured. We need such a harmonized index for the globe. Gold would be a good proxy however others would be possible. Keynes envisaged the Bancor.

    The Aussie Dollar has been worth about 55milligrams of gold for a decade now. It moves about this point but not by much. We could transition to a gold standard with more ease than most nations. And the added liquidity that this change of policy would bring would allow for a lower interest rate without sparking inflation. Gold leasing rates are very low.

    Regards,
    Terje.

    P.S. Reading a good book about John Curtin at the moment. He did not like the gold standard. I suspect that the errors of 1925 had a lot to do with that.

  11. brian
    September 19th, 2005 at 02:36 | #11

    Elizabeth asked about an alternative place nations and individuals could go to place their investments in view of the “crisis of the the US dollar”. The answer is quite obviously the banks of the “Eurozone”.” The Financial Times “recently reported that there was plenty of evidence of a large surge of Arab money…especially from the Gulf States and the Saudis , into Euros…not to mention that old golden favourite ,and rock-solid currency,The Swiss Franc.George Bush’s friends at the House of Saud are too canny to risk their cash,and the Euro is a safe haven. The US dollar is a bit like the Road Runner in the old cartoon ,where he could run on air until he looked down,in which case he had a sudden and disasterous fall. For the moment the Chinese Govt. banks which hold vast reserves of US dollars,don’t want to see their hoard devalued so they want to avoid a crisis for the present,but the US now borrows 3 billion dollars a day on the markets,and it can’t go on forever. Poor old Uncle Sam is reduced to a sort of genteel poverty…depending ,as Blanche Dubois says in the famous Tennessee Williams play ,”Streetcar named Desire “..”on the kindness of strangers !”

  12. Stormy
    September 19th, 2005 at 07:22 | #12

    When two such irreconcilable, divergent views occur the problem, in all likelihood, is that the problem has not been framed–or asked–properly.

    We have two sets of economists, both using somewhat antiquated models, both assuming the world before us is the world mirrored in their models.
    One model assumes a world identical to 1986-1990 (domestic) or the late 1990’s (international).

    What significant events have happened since or during then that might invalidate both models?

    Let’s look at a two:
    NAFTA 1994
    China enters WTO 1999

    I would make a few observations here before proceeding:
    (1) The dates, while seemingly falling within the international model, are misleading. Each of these events took time for their full effects to mature.

    (2) Each of these events trigger what has been, at least among the uninitiated, the greatest exodus of jobs that the U.S. has ever known.

    (3) Foreign Trade Zones have proliferated and become increasingly more sophisticated, offering advantages that have not been fully understood.

    (4) Undeveloped countries, slowly, but in increasing numbers, have begun seriously bidding for western manufacturing and service sectors, holding as plums cheap labor and very juicy tax deferments, both of which simply cannot be matched in this world or the next.

    NAFTA and China’s entry into the WTO were watersheds, changing the economic landscape in ways never considered by any economic model. I have yet to see one model that assumes capital is mobile.

    So where are the economists in all this?

    Stuck with the models they learned in school, I expect. Not one of them has seriously looked at how money and capital now moves or how labor is now used. Not one. Occasionally one will make a nod to outsourcing, but then leave it out of the model.

    There were warnings that we were entering potentially dangerous uncharted waters, but they were ignored in the euphoria of globalization.

    Meanwhile, some hope, without any substantive reasoning or factual evidence, that China will suddenly become a consumer or that the dollar will be devalued, thereby making those companies that stayed in the U.S. suddenly competitive with those that left. Meanwhile the twin deficits soar—and economists like automatons repeat their favorite analyses again and again.

    Not a new thought in the group.

    The world has changed, but their thinking has not.

  13. Terje Petersen
    September 19th, 2005 at 07:30 | #13

    Floating exchange rates are a huge trade barrier. Many people skip trade opportunities because of the risk imposed by floating exchange rates. The EU and its EURO represents a huge reduction in this monetary trade barrier.

    Nobel Prize Winner Robert Mundell says it better than me:-


    Prices all over the world would be denominated in the same unit and would be kept equal in different parts of the world to the extent that the law of one price was allowed to work itself out. Apart from tariffs and controls, trade between countries would be as easy as it is between states of the United States. It would lead to an enormous increase in the gains from trade and real incomes of all countries including the United States.

    http://www.robertmundell.net/Menu/Main.asp?Type=5&Cat=09&ThemeName=World%20Currency

  14. Ian Gould
    September 19th, 2005 at 07:37 | #14

    Stormy

    Where’s your evidence for “the greatest exodus of jobs the US has ever seen”?

    Your assertion that economists assume capital is not mobile is simply incorrect.

  15. still working it out
    September 19th, 2005 at 14:45 | #15

    The possible coming collapse of the USD will probaly lead to higher interest rates and a big reduction in demand from the US consumer.

    The latter of these will be a problem for China as a large part of their economy (and particularly their economic growth) comes from exports to the US. China does have other options. It can export to Europe or re-direct its production towards meeting internal demand. With a 50% of GDP savings rate they have room to move. Either way though, there is likely to be a slow down in the Chinese and global economy which will result in a general reduction in demand for commodities. This will undoubtedly have a big impact on the Australian economy.

    The rise in interest rates will have a more direct impact on the Australian economy. We have had arguably the largest housing bubble in the world over the last few years and have very high levels of househould debt. Substantial rises in interest rates will be very bad news for us.

    Our savings rate is negative at the moment, so the money we are borrowing is coming from overseas. Probably denominated in overseas currencies. (With a bit of luck it is mainly in the USD). I do not know in what form the foriegn private debt is and I do not even know how to begin going about finding out. But its likely that who Australia owes money to and it what form will be crucial questions that international investors will quickly answer and act upon in the event of a major USD collapse.

    If the USD rapidly collapses in value investors will begin moving their money to safer currencies in a hurry. The first step in that process will be re-evaluating which currencies are safe. In that process, I cannot help feeling that Australia’s exposure to a downturn in commodities and high interest rates as well as our high CAD will put us towards the top of any list of countries that will be heavily negatively affected by a collapsing USD. The obvious conclusion is that the AUD is not safe and it may get sucked down with the USD with pretty ugly consequences for us all.

    That’s my amatuer take on it. I am probably wrong, but you can see why I am nervous.

  16. Terje Petersen
    September 19th, 2005 at 15:23 | #16

    The US dollar will only collapse in value if:-

    1. The federal reserve decides that inflation would be a good thing.
    2. The federal reserve runs out of collateral with which to defend the US dollar.

    I am not quite sure how much gold there is in Fort Knox however given that it is valued at US$42 per ounce rather than the market rate of US$450 per ounce I would say they have a lot more collateral than they would like people to know about.

  17. Andrew Reynolds
    September 19th, 2005 at 15:50 | #17

    Terje,
    As the British government found out on Black Tuesday, the costs of defending an illogical exchange rate position are high when the markets realise that it cannot be defended. So, I would add a third possibility:
    3. The federal reserve realises the position cannot be maintained indefinitely and therefore any costs in defending it are too high.
    I would think this the most likely position.
    .
    On the gold standard: in the short term I think you are right, a return to some fixed measure of value would make some sense. The question is what measure – gold has some attraction, the problem would be what would happen if there was either a supply or demand shock? If a new. large, source of gold was identified then the currency would be directly affected.
    The other problem is to look at the effects of this on gold production – effectively this would be fixing the price of gold at some level (I accept your 55 mg idea). This would effectively alter the economics of gold production, with some large effects on the viability of mines. Essentially, the costs of production will go up (in real terms) as current mines exhaust (assuming the most profitable are mined first). Eventually, as the more expensive mines come on stream, the costs will rise, squeezing profitability and therefore reducing production. Normally, this would result in an increased price – but this is not possible under a gold standard. As the supply squeezes, the money supply would have to reduce (or at least not expand) with some severe adverse effects.

  18. September 19th, 2005 at 16:07 | #18

    If the USD devalues to the point that US workers need to replace Chinese made goods, then the implication is that their economic standard of living will decrease by similar proportion. To me that sounds a drastic adjustment no matter how it is managed by the Fed and interest rates. The US has outsourced some of its industry to China. Come the day that the Chinese can afford to compete for these products with the American consumer, the two will have met somewhere towards the middle.

    The Chinese have been smart in keeping their currency low so as to build their industry up. But inevitably the time comes when they say, enough is enough, time for us to live some of the good life to. They stop just banking USD and buy some of the manufactures themselves. Output is finite due to the shortage of raw material, and so the USA will have to make do with less from China. Ie less full stop.

  19. Ian Gould
    September 19th, 2005 at 16:23 | #19

    Wbb,

    US wages would only need to depreciate to Chinese levels if US workers were no more productive than Chinese workers.

    US workers are amongst the msot productive in the world and the average US manufacturing worker, in dollar terms, probably produces several times as much output per hour as the Chinese worker.

    It’s also a mistake to look at the nominal Chinese wage as the total labor cost, leaving aside all the overheads, the risk premium, the Chinese bureaucracy and the longer piepline of products (and the associated loss of flexibility), employers in China typically have quite high overheads since in many instances they are also expected to provide food, accommodation and health care for their workers.

  20. September 19th, 2005 at 16:53 | #20

    Chinese families live on the smell of an oily rag, and even multiplying by factors of 5 or 6 or 7 etc – still doesn’t approach the std of living we are accustomed to buying? I understand what you are saying – but I still see room for a very large adjustment – eg back towards the levels of wealth of the period prior to when all this work was being done for us by the unproductive but willing Chinese.

  21. Terje Petersen
    September 19th, 2005 at 21:16 | #21

    Andrew,

    On Black Tuesday the British were trying to defend too targets. An internal interest rate target and an external exchange rate target. Complete folly. Under attack one of them had to give. They should have let interest rates float and defended the exchange rate, or else not got themselves into such a contradiction in the first place. They decided otherwise.

    Note that China never had any problem defending its fixed exchange rate. Neither does Hong Kong. That is because their was no ambiguity.

    You are right to note the production squeeze on gold mines under a gold standard. Here is how I articulate it:-


    ~
    A gold miners product is gold. Under a gold standard the nominal price that the miner can charge for his/her product is fixed. One gram of gold is always going to sell for one gram of gold (no more no less). However the costs of mining are not fixed. The cost of tools or labour can move up or down. Labour may cost one gold gram per hour this year but 1.1 grams next year.

    If the level of gold production means that the system is inflationary (ie too much gold entering circulation) then marginal gold miners will go broke.

    This is why a gold standard generally delivers monetary stability.

    We should not pain ourselves with the prospect of gold miners going broke. They produce a product that can be neither eaten for sustinence nor burnt for warmth. Its only significant utility is as a monetary item.
    ~

    The British economy grew enormously during the 1800s. However over the century the price level halved. Gold doubled in value over the period meaning that prices fell on average about 0.5% per annum. Not perfect stability but perfectly acceptable.

    Critics often cite the hypothetical problem of a big gold discovery. “What if a gold meteor hits the earth?”. I am content to deal with those highly improbable events when they occur. History tells us that we can abandon a gold standard if we decide to. Why abandon it just on the possibility that something may go wrong at some unspecified future date.

    Of course even with gold as the monetary unit inflation can occur in responce to a sever supply shock. This is in essance what caused the inflation following the plague in medieval Europe. The gold stock stayed constant but a large part of the population (and supply) was decimated. A classic example of how an economic contraction can cause inflation.

    And if you make the mistake that Churchill did in 1925 you end up with a deflationary gold standard.

    Regards,
    Terje.

  22. Andrew Reynolds
    September 19th, 2005 at 23:14 | #22

    Terje,
    It does deal with the prospect of too much gold entering the system – it does not deal with too little. To hold prices stable in an economy growing at (say) 3% the volume and/or speed of money will need to increase by a cumulative 3% per annum. While monetarism is not popular, that does not mean that you can simply ignore MV=PQ.
    The system would either require greater and greater efficiencies in the usage of money and / or more gold every year. Not impossible, by any stretch, but something that would have to be dealt with by some mechanism.

  23. Ian Gould
    September 20th, 2005 at 07:40 | #23

    A more likely event to impact the gold standard than a gold meteor is a big change in demand for gold for non-monetary methods whether that be a slump in demand for gold by the microelectronics industry or a surge in demand from the jewellery market (as is currently happening in India).

  24. still working it out
    September 20th, 2005 at 08:09 | #24

    Current amount of gold stored in Fort Know = 147 million ounces
    http://en.wikipedia.org/wiki/Fort_Knox_Bullion_Depository

    147 million ounces * $450/ounce = $66 billion

    US Current Account Deficit = $195.7 billion (second quarter of 2005)
    http://www.bea.gov/bea/newsrel/transnewsrelease.htm

    $195.7 billion per quarter = $65.2 billion per month

    All the gold in Fort Know is enough to cover the US Current Account Deficit for about one month.

    The US has other assets and can issue enormous amounts of debt, but it is unlikely to go around selling assets on a massive scale to prop up the currency. It cannot issue the huge amounts of new debt required without raising interest rates significantly, especially if the major reason the currency is falling is the drying up of demand of for US government debt due to Asian central banks pulling out of the market. The massive government budget deficit has also limited their room to move on this front.

    “Note that China never had any problem defending its fixed exchange rate.”
    That’s because China has a savings rate of 50% of GDP and those saver’s are willing to put up with interest rates of 1%. And even they will have problems soon (which is actually the primary reason the USD will have to be devalued). At present the US has no savings at all. To defend its currency it will have to issue new debt, but because the savings rate in the US is so low the major source of new debt is overseas, which won’t help them defend the currency.

  25. Ian Gould
    September 20th, 2005 at 14:16 | #25

    >At present the US has no savings at all.

    I think this is misleading – yes the traditional measure of consumer savings is based on current earnings less current consumption and on this measure US savings rates are near zero or even negative.

    but this measure assumes that the net savings from previous periods are negligible. In reality of course, US consumers and companies have extrmeely large asset portfolios which have continued to appreciate.

    Much of that appreciation is attributable to the rise in US housing prices which may prove unsustainable but much of it also reflects investment in growth assets – including foreign assets.

  26. still working it out
    September 21st, 2005 at 14:13 | #26

    Yes, but if you are going to talk about assets then you have to take into account liabilities, and that is really at the heart of the problem. The Net Foriegn Debt of the US is about $3 trillion (i may be out here, I’m relying on an estimate from late 2004)

    The problem with the low savings rate is not that they don’t have funds, but rather that if they need funds in a hurry they will have to move substantial amounts of income from consumption to repaying debt (or buying overseas debt) to defend the currency. A massive fall in consumption is practically by definition a recession, and possibly a very bad one. If they had a high savings rate (like China for example) then putting large amounts of money into defending the currency would not affect local consumption because the money they would be using would have been going into savings anyway.

  27. Razor
    September 21st, 2005 at 16:32 | #27

    Terje’s dictum – “The fundamental task of monetary policy should be to maintain the currency at a stable value.”

    I issue an economics based WTF??? Since when??

    “Floating exchange rates are a huge trade barrier. Many people skip trade opportunities because of the risk imposed by floating exchange rates.” – Now that is a load of old todger as well – there are well developed markets to offset the foriegn exchange rate risks and interest rate risks of doing international business. That is why things such as futures and swaps exist.

    And, having only skim read what is above and risking repeating what others have said – if you think the USD is going to do something then have the guts to place your money where your mouth is – there are plenty of very inexpensive ways of taking a position in currency futures for the average punter. If you can post on this site then you can do that.

    In general, if you don’t like holding USd, then hold the pound or the Euro or the Yen or gold or… I could go on, but I won’t.

    As for the Nobel Prize winner quoted above – was he really advocating having one international currency????? The Euro is demonstrating the problems this causes – they can’t even stick to the rules as it is!!!

  28. craigm
    September 21st, 2005 at 22:04 | #28

    Razor

    Your point about hedging currency exposure is spot on, but you might want to rethink your suggestion that the average punter should be using them for speculative purposes.

  29. craigm
    September 21st, 2005 at 22:13 | #29

    Sorry

    using futures for speculative purposes.

  30. Terje Petersen
    September 22nd, 2005 at 07:49 | #30

    QUOTE:As for the Nobel Prize winner quoted above – was he really advocating having one international currency????? The Euro is demonstrating the problems this causes – they can’t even stick to the rules as it is!!!

    RESPONSE:Mundell does not advocate a single world currency. He advocates a common world currency. Just as English is the common language of Science but not the only language used in the world. The US dollar currently acts as the common currency. Oh and Mundell is sometimes called the father of the EURO so if you don’t believe there are any benefits flowing from the EURO then we are polls apart.

    QUOTE:if you think the USD is going to do something then have the guts to place your money where your mouth is

    RESPONSE:Thats like saying don’t argue politics just bet on the outcome of elections. Its like saying I don’t care if the RBA decides double its print run so long as I know about it early enough to profit. In essence you are taking a “Who Gives a F***” approach to the issues.

    QUOTE:there are well developed markets to offset the foriegn exchange rate risks and interest rate risks of doing international business.

    RESPONSE:So if Queensland adopts its own currency that floats relative to the currency of NSW you think there will be no impact on cross border business? I think you underestimate the nature of uncertainty in business and you underestimate the loss involved in hedging. Hedging involves a net transfer of wealth to parties secondary to the trade of physical goods.

  31. Razor
    September 22nd, 2005 at 12:53 | #31

    craigm – perhaps a disclaimer should have been attached –

    “This advice has been prepared without taking into account your objectives, financial situation or needs. Therefore, before you act on the advice, you should assess whether it is appropriate for you, in light of your objectives, financial situation or needs.

    If this advice recommends that you should acquire a particular financial product, you should obtain a Product Disclosure Statement for that product and consider the information in it before deciding to acquire the product.”

    (And people give me crap for posting anon – the above is a good example why.)

    I am not recommending currency speculation to anyone, but if they have a strong view about the issue and the right risk tolerance, it can be done. Speculators take on the risk of those who don’t want risk.

    Terje

    The recent performance of the RBA, the FED and the Bank of England clearly demonstrates that the fundamental task of Monetary Policy is to control price inflation (not asset bubbles!!). Not buggerise around trying to manage exchange rates – they’ll never win at that game.

    I have not been convinced that the benefits of the Euro outweighed the costs – loss of control over a major tool of economic policy and then allowing particpants to operate outside the rules makes it a joke. The UK were 100% correct to stay outside – look how succesful their economy is now compared to Germany and France. Single/common currency – six of one and half a dozen of the other. Free floating is the best model.

    You are totally wrong about me not giving a toss – I feed my kids based on the outcome of issues like this. I also both argue and bet on elections (and unlike my horse racing and footy tipping have done suprisingly well).

    I have no idea why you think that you need to use an example of trade between two Australian States. Hedging risk will always involve a cost and that cost is borne by the consumer because physical traders who look to lower their risk have a cost to be passed on. My business premises have an expensive security system and insurance. That is a cost to reduce the risk of theft and fire. The cost is passed on to the consumer – just as hedging costs to reduce the risk of currency fluctuations is.

    There are ways of reducing risk using options that allow only downside risk to be removed rather than just locking in a currency price with a futures contract – which can mean that the hedging isn’t actually a cost, but a revenue item. (Didn’t work for the Sons of Gwalia Gold book though).

  32. craigm
    September 22nd, 2005 at 14:34 | #32

    Razor taking a view is speculation and suggesting that the average person should use futures to speculate is spectacularly bad advice.

  33. Razor
    September 22nd, 2005 at 14:57 | #33

    Take your hand off it craigm. There is a difference between having a view and actually putting your money where your mouth is.

    “Speculation
    From Wikipedia, the free encyclopedia.
    Speculation involves the buying, holding, and selling of stocks, commodities, futures, currencies, collectibles, real estate, or any valuable thing to profit from fluctuations in its price as opposed to buying it for use or for income ( via dividends, rent etc). Speculation or agiotage represents one of three market roles in western financial markets, distinct from hedging and arbitrage”

    … and in the context of the discussion above we were talking about hedging, not speculating.

    As for sweeping generalisations – claiming I am giving advice and that also that said advice is bad advice jumps through quite a few assumed hoops.

    Give it a rest and stick to the discussion which is titled “the coming dollar crisis”. If somebody beleives there is a crisis coming then it is rational behaviour to act positively in relation to that. The truth is that those who peddle this crap are unlikely to put their money where their mouth is.

  34. Katz
    September 22nd, 2005 at 15:14 | #34

    Spot on Razor.

    Currency speculation runs the entire gamut of risk exposure.

    Foreign exchange markets are by two orders of magnitude the most liquid and efficient markets on earth.

    It is within the competence of everyone, from your figurative mum and dad to the largest corporations and nations, to calibrate with almost infinitessimal exactitude their desired level of exposure to foreign exchange risk.

  35. craigm
    September 22nd, 2005 at 15:22 | #35

    You are quite forthright about being financial advisor or fund manager or whatever you are so you should not be giving out such poor advice from a position of self proclaimed expertise or do you have a different definition of “average punter”.

    Putting your money where your mouth is doesn’t sound like advice on hedging currency exposure to me.

    Where I have my hand is none of your business.

    Now carry on.

  36. Terje
    September 23rd, 2005 at 13:07 | #36

    QUOTE:The recent performance of the RBA, the FED and the Bank of England clearly demonstrates that the fundamental task of Monetary Policy is to control price inflation (not asset bubbles!!). Not buggerise around trying to manage exchange rates – they’ll never win at that game.

    REPONSE:In summary you maintain that the best way to control price inflation is to buggerise around with interest rates. Whilst I maintain that the best way is to buggerise around with the value of the currency as measured in commodities (specifically gold).

    QUOTE:Hedging risk will always involve a cost and that cost is borne by the consumer

    RESPONSE: As I said it is a trade barrier. Tariffs are also a cost that is borne by the consumer. Trade between NSW and QLD does not involve either cost.

  37. Razor
    September 23rd, 2005 at 16:14 | #37

    Fair enough – risk is cost, but I really don’t think it falls into the category of trade barrier just as a language difference isn’t strictly a trade barrier.

    I still can’t come to grips with why you persist in thinking some sort of pegging can be succesful for currency management – Central Banks simply do not have the firepower to force the markets to move in directions they don’t want too. Free floating has proven to be very successful.

  38. Terje
    September 23rd, 2005 at 19:00 | #38

    QUOTE:I still can’t come to grips with why you persist in thinking some sort of pegging can be succesful for currency management – Central Banks simply do not have the firepower to force the markets to move in directions they don’t want too.

    RESPONSE:Sorry but that is completely untrue. Hong Kong has done it for years and still does. The USA whined when China did it. Great Britian did it for more than a century as did the USA.

    The only time a central bank can’t fix the exchange rate is when it is busy fixing the interest rate. They can not use the M0 money supply to control more than one price. However they have total power over the control of any single price.

    Free floating has not proven to be successful. During the 1970s, 1980s and early 1990s (ie the first two and a half decades of floating currencies) the general result was severe inflation. Even as they have belatedly got consumer prices under control they still manage to whiplash global commodity prices all over the shop.

    Then the USA (post WWII) fixed the exchange rate of the US dollar to gold the domestic inflation rate remained low and global commodity prices remained stable. This is not some untested notion. We have several hundred years of data to draw on.

    http://en.wikipedia.org/wiki/Open_market_operation

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