Foreign Banks Mull Whether to Prop Up the Dollar

March 17, 2008 04:21 PM
by findingDulcinea Staff
Foreign central banks are considering a coordinated effort to buy U.S. currency to support its international trading value. Economists debate the plan's effectiveness.

30-Second Summary

Stephen Jen, a foreign currency markets analyst for Morgan Stanley, predicts that other countries’ central banks may start buying U.S. dollars to prop up its value. Theoretically, such coordinated buying could halt a slide in the currency’s value caused by speculators looking to create short-term profits.

Eben Esterhuizen, writing on in finance blog Seeking Alpha, offers five reasons why the central banks should intervene. He argues that if central banks coordinated their efforts, they could maintain the dollar’s value.

But the jury is out on whether or not such central bank intervention is effective in quieting the volatility in currency values

The laws of supply and demand apply to foreign exchange markets just as they do to stocks or goods and services. If there is a rush to buy a given currency, as the Federal Reserve of Kansas City writes, a “bandwagon” effect can kick in, pushing up its value on the international markets. As the overall effects tend to overpower the actions taken by a particular government, “central bank intervention typically appears to have had little effect on volatility.”

German economist Peter Bofinger says in Forbes magazine, "The uncontrolled increase of the euro rate vis-à-vis the dollar threatens employment growth in the euro area.”

He continues, “I think what would be needed is to find an agreement between those countries holding large dollar reserves."

The European Central Bank, whose home currency is the euro, will have to loosen its monetary policy before it will take action, Jen believes. Emerging-market economies such as Saudi Arabia and China would have to support an international intervention to keep the greenback afloat.

Other countries that import goods from the United States find that a strong U.S. dollar is in their best interest, because it means cheaper imports from the United States and a more competitively priced workforce. The United Arab Emirates is considering abandoning the dollar peg for the dirham, its national currency, because costlier imports are driving up inflation to between 20 and 30 percent.

Headline Link: 'Morgan Stanley: Odds of Dollar Intervention Are "Rising"'

Background: Currency reserves and their effect on exchange rates

Historical Context: Past interventions

George Soros and Black Wednesday
Turkey’s second-quarter 2006 crunch

Opinion & Analysis: The efficacy of currency intervention

Central bank intervention has little, if any effect on currency markets
Central bank intervention is effective

Reference: The U.S. economy

Related Topic: The U.S. dollar’s loss of prestige abroad

Related Topic: Commodities prices skyrocket


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