The decline of the dollar

So many bizarre things are happening in global financial markets that it’s impossible even to keep up with the critical events (today for example, more European countries guarantee deposits, 1 per cent cut in interest rates, US Fed starts buying commercial paper), so I’ll focus on one thing that has struck me. A few months ago, the Australian dollar was close to parity with the US. Since then it’s become apparent that the US financial sector is essentially insolvent, and that the US government is relying on the printing press to meet its obligations, while, by any reasonable standard of comparison, the Australian economy looks remarkably sound. So, in their infinite wisdom the financial markets have sold off the Australian dollar (as of today, it’s worth about $US0.72).

In the current environment, a big devaluation is probably beneficial for the Australian economy. It more than offsets the decline in ($US-denominated) commodity prices we’ve seen so far.

Still, on any reasonable assessment, the movement in the market exchange rate is plain crazy. At this point, the claim (essential to the efficienct markets hypothesis) that market-determined asset prices represent the best available estimate of future values, and therefore that capital markets are the best available method of allocating scarce resources for investment can only be sustained on the basis of the kind of dogmatic belief that asserts that humans and dinosaurs shared the earth 6000 years ago.

45 thoughts on “The decline of the dollar

  1. “It more than offsets the decline in ($US-denominated) commodity prices we’ve seen so far.”

    The prediction apparently is that China has peaked and commodity prices are headed south. So the Australian dollar has fallen against everybody, not just the US.

  2. Thanks Prof.

    I thought I was being really dumb, not knowing why the dollar was plummeting like it has been. I think I’m a fairly good economist (I’ve forecast for JEFG and got it right!!!), but when I was asked by a non-economist friend today why the dollar has fallen, I couldn’t explain it.

    It’s good to know that I am not alone with a furrowed brow. I would have thought that printing money would have devalued the US currency against all others, including the AUD. I would have thought that this would have pushed the AUD above parity, or at least maintained the AUD above USD0.90. I understand the commodity story, but there are massive forward contracts, so the spot price shouldn’t matter terribly much for currency positions today.

    Hmmmmmmm. Confused!

  3. People want to shift to the “safety” of hard currency, and at the moment for some reason that means US treasuries. Hence the USD goes up.

    It’s obviously a strategy for failure, but that’s been obvious for some years now, e.g. with China investing in US financial assets that were inevitably bound to devalue.

    Brad Setser will probably come up with a plausible explanation in a few days.

    On the other hand, it could be some stupid hedge fund strategy that’s also going to end in tears.

  4. Our markets at the moment are much like the Britney Spears soap opera. To even attempt to rationalise the day to day fluctuation in the market is like trying to find a needle in a haystack. One things for sure we are headed for financial oblivion as the value of our assets and cash is flushed down the economic toilet.

    You can’t expect markets to behave in a rational fashion, when you have central bankers and nervous democratic leaders tweeking our economies in an effort to save our purchasing power. I am however certain they will save face. Well at least save democracies “face”.

    It is a complete failure of our current democracy to provide us with the transparency we are entitled to have to make rational decisions in daily life transactions….

  5. At first glance the movement seems at odds with common sense until you look at past history. At one stage the Aussie was worth about 46cUS rising dramatically to a maxm of 98.5c just recently on the back of record commodity prices and some of the highest official interest rates globally. That’s one hell of a shift in relativiries. Clearly with that 1% rate cut today, the last 2 rate rises by the Reserve were just plain wrong in the big scheme of things. Interest rates and commodity prices going south means ditto for our dollar now, given our overall borrowings, although no doubt in times of financial crisis, corrections will be overdone.

  6. VIX hit 58 last night (Monday in the USofA), closing at 52. Knocked out of the ballpark.

    Strange days indeed.

  7. China and a number of other countries with large US asset portfolios are selling off non-US assets in order to buy up T-bills and other US assets in an attempt to protect their portfolios.

  8. The financial crisis is global. The US is the only country large enough to have a chance of dealing with it. The Europeans potentially could, but as in most things, they are rather ineffectual.

    So while US treasuries are a pretty poor bet, all other bets are currently worse. Hence US $ is going up.

    At this point, the claim (essential to the efficienct markets hypothesis) that market-determined asset prices represent the best available estimate of future values, and therefore that capital markets are the best available method of allocating scarce resources for investment can only be sustained on the basis of the kind of dogmatic belief that asserts that humans and dinosaurs shared the earth 6000 years ago.

    Ah yes, let’s return to the Halcyon days of central-planning, soviet-style. Those guys really knew how to allocate scarce resources efficiently. Or if not efficiently, at least equally: no one got jack.

  9. The entire world economy is in flux. Share markets in the US have been dropping like a stone and occasionally recovering like one of those bouncy super-balls. Market volatility is expressed by substantial and continual rises and falls in prices across every part of the spectrum.

    The Aussie Dollar isn’t dropping because of a perceived lack of faith in the Australian economy just as much as the US Dollar isn’t rising because of America’s supposed strength.

    The dollar is rising and falling due simply to uncertainty. In normal times, a rate cut would lead to a drop in the dollar. But with little else to go on, forex markets jumped on the decision in order to make a profit out of shorting.

    These are interesting times.

  10. Thanks for the post, I couldn’t understand this either. I’m not involved in money markets but I don’t understand why people are so panicky about the demand for our resources from China either. 80% of China’s output is to satisfy domestic demand – its not all cheap exports to the US. That will still continue. Most commodity exports from Australia are long term contracts. They might stop growing but current demand from them will continue. The US and Europe are in recession, but that matters much less to our exporters. I conclude that most money traders are still over-reacting cowboys just as one of my (UQ economics) lecturers described them to me 20 years ago.

  11. The old trope ‘if you pay peanuts you get monkeys’ was used to justify huge salaries paid to the mavens in money markets, the theory being that huge salaries somehow attract huge financial brains and huge financial talent. The myth of ‘huge salaries and cash bonuses will attract intelligence’ has been totally destroyed once and for all by the current crop of leaders, captains of industry, financial savants, and, politicians. Some of these people are telling us what shape the world will be in in 2030 yet those same augurs can’t tell us what will happen next week.

    I’d like you all to join me in prayer.

  12. We have indeed got monkeys running our markets. Another idea that I find irrational is that paying huge performance bonuses will somehow “align” executives interests with those of shareholders. It clearly does not. All it does is give the executives a strong incentive to gamble with other people’s money. Golden parachute clauses mean that its a no lose bet for them, and eventually a loss for the rest of us.

  13. One factor in the decline of the AUD that doesn’t get talked about much is the effect of the carry trade. Until recently the AUD was used as one leg in a carry trade, typically against the lower yield JPY or CHF. When people lose money in one part of their portfolio they tend to sell off other parts to lower risk, that means selling AUD and buying back JPY and CHF. Before anybody gets excited that this shows how greedy bankers are mucking up everything, or how this disproves EMH, or accuses anybody of being a creationist, remember that the carry trade is created by central bank intervention in the money markets. If anybody is really outraged by this I suggest they become an Austrian — I’m sure Observa and BBB can recommend some books.

  14. Still, on any reasonable assessment, the movement in the market exchange rate is plain crazy.

    Insider trading? There must be a hell of a lot of that going on right now, all over the globe.

    But of course everybody is too busy and too panicked to notice…

  15. I would like to hear John’s thoughts on where the middle ground between the unregulated capital/money market and central planning currently is. Personally I would like to see a heavy Tobin tax that would penalise short term money market panics and manipulation.

  16. gandhi,
    I’m not sure how anybody could be an insider trader in currency markets.

  17. Joseph (and others). Before making recommendations for a return to the gold standard, abolition of central banks and so on, you might want to consider the Panic of 1873 and the subsequent Long Depression (see also Hungry Forties, Panic of 1893, Panic of 1907, Australia’s 1890 Depression and so on).

    The idea that financial panics are a product of central banking and fiat money derives its plausibility only from the fact that no-one can now remember the panics of the pre-central bank era.

  18. surely fiat banking per se is not the problem

    but the temptation that goes with it

    i think the most important currency is truth

    the americans divorced from the truth about themselves and their role a long time ago

    there was only one possible outcome then,

    i mean turn on the television, mcdonalds sell health food, credit cards give you freedom, 4wds come from the earth itself

    we are drowning in a culture of lies, that is why the system is failing, the funny money is just one aspect of it

  19. It’s tempting for those of us on the left to say that the current crisis was a result of specifically American factors and the current Republican administration.

    As the banking crisis in Europe rolls on, it becoems increasingly difficult to do so.

  20. “Joseph (and others). Before making recommendations for a return to the gold standard, abolition of central banks and so on […]”

    I’m not recommending that though I’m sure you’ll provoke the argument from others. I’m just saying that laying all the blame on the Big Bad market is not credible. If your argument is a preamble to currency controls (is it?) you are in no position to lecture people for forgetting the lessons of history.

  21. Why doesn’t the US dollar decline?
    http://www.atimes.com/atimes/Global_Economy/JJ07Dj07.html
    Well if you don’t exactly think Sarah Palin for President is the answer to Father Mercy’s solicitations right now, it does point to why the ponzi scheme was joined so avidly by Asian savers for so long. As Spengler so neatly encapsulated the world of finance before-
    “There is nothing complicated about finance. It is based on old people lending to young people. Young people invest in homes and businesses; aging people save to acquire assets on which to retire. The new generation supports the old one, and retirement systems simply apportion rights to income between the generations. Never before in human history, though, has a new generation simply failed to appear.”

    The planets of demographics and Asian savings aligned to conspire against the well intentioned bumblings of central bankers to oversee the orderly intergenerational apportionment of income rights and here we all are. So much of our fiat money (really illusory savings) is irredeemable now and the problem is too many of us know it. Doesn’t stop us all from trying though.

  22. “I’m not sure how anybody could be an insider trader in currency markets”

    Er… George Soros. Pound Sterling. Black Wednesday 16 September 1992. $1.1 Billion profit overnight.

  23. Observa

    I agree with your comment on intergenerational transfers and think that explains the asset inflation that has occurred throughout the 90s. However, my understanding of demographics is that the US population is actually older than ours (a bigger baby boom), so I still don’t see why our dollar has gone down so much vis a vis the US dollar? Shouldn’t the US dollar go down the most?

  24. intergenerational transfers … that explains the asset inflation

    using a comparative methodolgy and looking at say, the rest of history, i’d say that just doesnt add up

    and damocles, making a billion dollars in a day betting on the movement of a currency is sick
    you are not defending an economic sickness, you are defending a cancerous mental illness that is directly contributing to the killing of life on this planet

  25. My hypothesis is: Regarding the recent history, the exchange rate of the US$ has increased, relative to the A$ and the Euro and others, more than could be explained by relative international accounts statistics and relative monetary policy moves, because a relative shortage of US$ has developed as a consequence of the scramble to exchange ‘private money’ (debt securities issued by private institutions) denominated in US$ for US$ fiat money.

    For example consider ‘financial distress’ with the limiting state being ‘default’. The redemption of the distressed financial debt security involves an amount that is within the range [0, US$<contract amount]. The contract amount is denominated in US$ but it has been decided not by the FED but by ‘the market’. Any positive redemption value represents a demand for US$ fiat money. Foreigners compete for the same US$ fiat money.

    There are also reports of hoarding of cash by banks (ie increasing deposits with the central bank). There is nothing ‘irrational’ about it and the ‘lack of confidence talk’ doesn’t impress me either. If banks hoard money (fiat) then they either plan to take-over other institutions or they wish to be able to meet their fiat money obligations, assuming that the short-term credit market remains ‘dry’. The ‘market’ which is supposed to coordinate individuals’ decisions does not exist (fails to work) and hence everybody is on their own and makes the best decisions they can.

    In short, I say the existing and widely known theories of exchange rate determination fail to take into account the financial sector (a ‘coordination problem’ in some sense).

    For those who are, in one way or another, stuck with the Austrians or the Gold standard, I suggest reading H. Minsky’s financial instability hypothesis.

    The ‘efficient market hypothesis’ (strong form), written and promoted by Fama about 30 years ago, states that ‘all available relevant information’ is fully reflected in asset (securities) prices. Fama’s hypothesis is not testable statistically or by means of examining theoretical conditions against empirical observations (text theoreticians do not specify conditions). Suppose one were to conclude that Minsky’s financial instability hypothesis is consistent with several historical episodes. Then Minsky’s financial instability hypothesis would, in Fama’s mode of theorising, presumably constitute ‘relevant information’. The resulting notion of ‘efficiency’ contradicts every other notion of efficient resource allocation I am familiar with in Economics. Fama’s hypothesis would come close to saying ‘the securities market is always right’, whether or not there is a market for food, fuel, housing, and irrespective of whether equine influenza spoils a profitable sporting event or brings the transport system to a halt.

  26. 11: Socrates: “Most commodity exports from Australia are long term contracts. They might stop growing but current demand from them will continue”.

    “But there is a strong argument that India and Australia are, for different reasons, quite exposed despite claims by many local commentators that they are relatively well protected. Take Australia. …… It is only a matter of time before Chinese mills demand – and get – big price concessions for iron ore and coal…… the additional supply coming on stream from iron ore miners Fortescue suggests that the price cycle downturn will be accelerated….. export prices peaking out and import prices rising as the Australian dollar goes into reverse against almost all of its supplier countries…. the cost of funds is likely to stay relatively high ….Antipodean households are excessively indebted, particularly for housing”. Philip Bowring

    Re interaction of global slowdown and AUS private debt of 165% of GDP try Steve Keen’s Debt Deflation

  27. Maybe it is time for a bold government move. Say goodbye to the Keating floating dollar even if it is a temporary measure. With another 3 cent drop today something has to be done.

  28. “What was Soros inside?”

    He used information not available to the public (his short position on sterling) to affect the price of the currency.

    “Joseph, he MADE MONEY. So he must have been guilty of SOMETHING.”

    I suppose you can overlook fleecing every British citizen and everyone legitimately holding Sterling reserves. Looks like theft to me.

  29. Hal9000,
    That’s not insider trading, it’s just regular trading. You may not like the prices that markets provide but the alternative is some form of central price setting.

    I’m not happy about (for example) house prices rocketing up in the last decade because I don’t own a house. Many people I know — and probably many people here — have made hundreds of thousands of dollars in capital gains just for sitting around on their bottoms. I’m not happy but I think it would be a far greater evil for governments to set the price of houses.

    Are you not sceptical about the ability of governments to set prices? Currency controls are a very dark and dangerous path to go down. You don’t have to be a libertarian to see that danger.

  30. whatever ills the financial banksters create,
    he who points out or complains will be menaced eternally with the dark spectre of ‘central price setting’

    i am shaking in my boots

  31. “He used information not available to the public (his short position on sterling) to affect the price of the currency.”

    So every trader who doesn’t announce their intentions in advance is guilty of insider trading?

    That’s an interesting theory.

  32. Damocles,

    And profiteering. From the poor. You know who most of the bankers are don’t you? That’s right. Jews.

  33. SJ, I definitely don;t think you’re anti-semitic by any stretch of the imagination.

    I do however think that much of the criticism of Soros is based in anti-semitism – google “Soros” and “Son of Shylock”.

    You might want to ask yourself how one reconciles the image of Soros as a greed-crazed bastard out to suck the blood of the poor with the billions (literally) he’s donated to charities in Eastern Europe and elsewhere.

  34. Damocles, that’s easy to reconcile in several ways:-

    – mental compartmentalising;

    – an almost antinomian philosophy, as in Rockefeller, who thought he truly was intrinsically outworking something worthy and so did not need to enquire any deeper;

    – PR, as in a cynical view of Bill Gates;

    – sheep’s clothing, as in Jabez Spencer Balfour.

    Of course, these sometimes overlap and sometimes are inconsistent, and any or none of them may apply. I’m only trying to make the point that Soros could well be both the things you describe, I’m not trying to pick any particular answer or even to assert that either or both do apply. That is, just to show the potential range of things I’m sketching out a range of hypotheses that would need testing to be relied on. I’m not actually doing that testing against empirical evidence to firm anything up.

  35. Does the same analysis applies to why our (Canadian) dollar has dropped about 8 cents compared to the U.S. dollar over the last couple of weeks? I had thought maybe it was because Oil was declining (The USA imports more oil from Canada than any other country), but I’m not an economist, and I find this all rather puzzling.

  36. Yes indeed Chris – it’s a reaction by the markets to falls in commodity prices (including but not limited to oil). We’re both big commodity exporters.

    Note that while the falls are big, the level of the $A and the $Can are still around pre-commodity boom levels and are now probably somewhere near PPP. So perhaps it’s more the market retreating from unrealistic highs than diving to unrealistic lows. Still, there goes the bargains I’ve been buying over the internet from the US in the last year or so. And you can now expect resumption of the carry trade in pharmaceuticals fom Canada to the US too.

    The fall in commodity prices reflects pessimistic assessment by buyers of demand next year, so it’s an ominous indicator of the collapse in the casino economy spreading to the real economy.

  37. Joe2, that bold government move would require an increase in the cash rate. Is that what you really want? And why does something have to be done?

  38. Derrida said: “the level of the $A and the $Can are still around pre-commodity boom levels and are now probably somewhere near PPP”

    eh? I am in the US at the moment, and I can tell you, the $A is nowhere near PPP now. It’s not pretty.

    I see nothing rational in the movements of the AUD over the past week.

  39. Hal9000: “He used information not available to the public (his short position on sterling) to affect the price of the currency.”

    Rubbish. The opportunity was plainly obvious at the time – I made money on the same trade (although not nearly as much) and I was on holiday at the time for heavens sake.

    I walked into a bank to take some money out in AUD (intending to leave most in GBP), was told the price (2.84) and said “how much?????, hell give me the lot”

    6 weeks later I bought it all back at about 1.76.

    Good times (wish I could do it again)

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s