In This Article
30-Second Summary
Headline Link: 'Morgan Stanley: Odds of Dollar Intervention Are "Rising"'
Background: Currency reserves and their effect on exchange rates
Historical Context: Past interventions
Opinion & Analysis: The efficacy of currency intervention
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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Foreign Banks Mull Whether to Prop Up the Dollar
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.
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"'
Morgan Stanley currency strategist Stephen Jen believes that foreign banks may start purchasing U.S. currency to bolster its value on the international currency markets. One reason is that the weak dollar is pushing up commodities prices, which are priced in dollars on the international market. This gives “the impression that inflation is high and rising in the world,” writes Jen, and as a result, foreign countries feel that they have to remain “vigilant on inflation by keeping interest rates high and currencies strong.” The second is that the weak dollar is eroding investor confidence.
Source: The Wall Street Journal’s Real Time Economics blog
Background: Currency reserves and their effect on exchange rates
Sterilized intervention is when a national monetary authority wants to protect its currency’s values compared to others. Writes Investopedia, “To weaken the U.S. dollar against another currency, the Fed would sell more U.S. dollars and buy the foreign currency. The increased supply of the U.S. dollar would lower the value of the currency. The Fed would do the opposite if it wanted to strengthen the U.S. dollar.”
Source: Investopedia
The value of the dollar can be adjusted by the United States with the Exchange Stabilization Fund. It consists of U.S. dollars, reserves of foreign currencies and special drawing rights, a type of bond created by the IMF that some developing countries use to store national funds.
Source: Department of Treasury
Historical Context: Past interventions
George Soros and Black Wednesday
In 1992, the Bank of England was wary of floating its currency or raising its interest rates to align more closely with those in other European Exchange Rate Mechanism (ERM) countries. On Sept. 16 of that year, hedge fund investor George Soros speculated that he could sell off his reserves of the British pound and buy it back at a cheaper price. He sold more than $10 billion worth in sterling, forcing the Bank of England to devalue its currency and pull out of the ERM. Soros earned some $1.1 billion from the transaction. He has come to be known as “the man who broke the Bank of England.” Sept. 16, 1992, has since gone down in history as “Black Wednesday.”
Source: Financial Realities 101
In the early 1990s, British financiers considered German monetary policy exemplary, and believed that if the pound were tied to the Deutschmark, it would solve Britain’s inflation woes. This did not alleviate a U.K. recession, however. BBC economics editor Evan Davis writes, “That tells us that the ERM may have worked better, if the interest rates had been set not by Germany for Germany, but by Europe for Europe (as they are in the euro).” With regards to any risks associated with the pan-EU currency, “The euro has benefits in terms of convenience and transaction costs that the ERM never had; and the euro can't be ripped asunder by currency speculation,” he writes.
Source: The BBC
Soros said at the World Economic Forum in Davos, Switzerland this January that the state of the U.S. economy marks “basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency. Now the rest of the world is increasingly unwilling to accumulate dollars."
Source: The Daily Telegraph
Turkey’s second-quarter 2006 crunch
The value of the New Turkish Lira plunged 20 percent against the dollar from April to June 2006. Causes included trepidation over Turkey’s potential entry into the EU, its mismanaged appointment of a new central bank governor, and a spate of mergers and acquisitions that prompted a speculative sell-off of Turkey-based assets by foreign investors. The Turkish Central Bank heavily bought the country’s currency from global markets, and, on June 28, 2006 the Turkish Central Bank increased the overnight lending rate by 2 percent to 22.25 percent to bolster the value of the New Turkish lira and stave off inflation. These steps succeeded in reversing the slide in the value of the lira, and indeed it has now more than completely reversed its slide relative to the dollar.
Source: International Herald Tribune
Opinion & Analysis: The efficacy of currency intervention
Central bank intervention has little, if any effect on currency markets
The Federal Reserve Bank of Kansas City explains the mechanics behind fluctuations in foreign exchange markets. First, information about new economic policies can lead traders and other market participants to change their predictions concerning the supply of money available. This has two other important effects on market rates: confidence and the “bandwagon” effect. If players feel that a currency will be strong, they will buy more of it, as they would a stock. This can have cumulative repercussions across the market. This means “central bank intervention typically appears to have had little effect on volatility.”
Source: FindArticles.com
Tony Caporale takes the Kansas City Federal Reserve’s analysis one step further, saying that “exchange rate intervention serves to destabilize the foreign exchange market by introducing additional levels of exchange rate uncertainty.”
Source: AllBusiness.com
Paul Krugman analyzes Federal Reserve Chief Ben Bernanke’s current domestic economic policy, comparing it to foreign-currency trading. In both cases, the markets in question are so huge “that even big interventions tend to look like a drop in the bucket. If foreign exchange intervention works, it’s usually because … the markets are getting hysterical, and intervention gives them a chance to come to their senses.”
Source: Paul Krugman’s blog on The New York Times
Central bank intervention is effective
Top German economic investor Peter Bofinger says that the European Community Bank should get directly involved with the exchange markets to protect employment and trade at home. "The uncontrolled increase of the euro rate vis-à-vis the dollar threatens employment growth in the euro area,” said Bofinger. “I think what would be needed is to find an agreement between those countries holding large dollar reserves,” which could include Germany, China, Japan, and the oil economies of the Gulf.
Source: Forbes
Eben Esterhuizen writes in blog Seeking Alpha that saving the U.S. dollar is crucial to the health of the global economy. A stronger greenback would mean reined-in oil prices and lower inflation. He says that a coordinated effort on the part of several central banks would be necessary for such a plan to be effective.
Source: Seeking Alpha
In their book “Does Foreign Exchange Intervention Work?” Kathryn M. Dominguez and Jeffrey A. Frankel argue that economic intervention via the trading of foreign currency can indeed have an impact. The book cites data from daily currency trading activities by the U.S. Federal Reserve and the German Bundesbank, and is available on findingDulcinea’s bookstore.
Source: findingDulcinea’s Bookstore
Reference: The U.S. economy
FindingDulcinea has a guide to understanding the U.S. economy, including where to look for opinions on economic policy and definitions of key economic indicators.
Source: findingDulcinea
Related Topic: The U.S. dollar’s loss of prestige abroad
A March 17 editorial in The Wall Street Journal argues that a strong dollar is crucial to a strong economy. While a weak dollar may help reduce the U.S. trade deficit as it would allow for cheaper exports, “rising exports won't comfort Americans whose standard of living falls due to rising import prices.”
Source: The Wall Street Journal (registration may be required)
The UAE has its currency pegged to the flagging U.S. dollar. But high inflation is forcing the Gulf nation to reconsider that arrangement.
Source: findingDulcinea
On Sept. 29, for the first time in the history of the two countries, the Canadian dollar eclipsed the U.S. dollar in value. The U.S. dollar traded higher for much of January and for about a week in late February; however the “loonie” is currently stronger.
Source: findingDulcinea
Related Topic: Commodities prices skyrocket
The price of gold reached $1,000 an ounce on March 13, and the Dow Jones Industrial Average dropped 200 points during morning trading.
Source: findingDulcinea
U.S. gas prices broke another record the week of March 10, hitting an average of $3.22 a gallon. Some experts believe oil prices could go significantly higher.
Source: findingDulcinea
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