Entries Tagged 'currency' ↓

I was reading some of your essays about the impact of the devaluation of the dollar. At first glance, this could cause a recession in the European economy (lower inflation, lower growth). But analyzing (with the little economic knowledge i have ) i came up with the conclusion that:
- Depending on the spare capacity the economy has, the falling of the dollar can have a positive long term growth. My argument is that companies will be able to produce more (buying raw materials at a lower price -assuming they are priced in dollar-) without having to pass the cost onto the consumers… Is this possible or am i wrong?
Appreciate your help

In recent months, the dollar has been devaluing and the Euro has been appreciating significantly.

If the Euro appreciates – what impact will this have on the European growth rate? Is it possible a very strong Euro could cause a recession in the Eurozone?

• If the Euro appreciates (increases in value) it makes the price of EU exports less competitive. Americans have to pay more dollars to get the same EU goods. Therefore, this is likely to cause a fall in demand for EU exports.

• Trade accounts for a large % of the Eurozone economy, therefore, a fall in exports will have a negative impact on the rate of economic growth. If the Euro increases too much it could cause serious problems for exporters and possibly a recession. Continue reading →

Against the dollar, the UK Pound sterling has experienced a rapid appreciation in the past couple of years. The Pound has strengthened against a backdrop of a strong economy, low inflation and relatively high interest rates. However, recent events have cause many to predict a lower value of the £ in 2008.

The Global Credit Crisis may hit the UK particularly hard.

Large Trade Deficit. The UK has a large trade deficit of 6% of GDP. This has been masked by hot money flows. However, the trade deficit suggests a fundamental imbalance and it is likely that a devaluation will be needed to rectify this.

Falling Interest Rates. UK interest rates are currently higher than the European Union and the US. However, a slowing economy and falling house prices make it more likely that interest rates will fall in 2008. Some predict interest rates could fall as low as 4%. If this was to occur there would be a big fall in the value of the £ as hot money flows dry up.

Slowing Economy. Despite large numbers of shoppers over the Christmas period, there is still concern that the economy could turn as falling house prices impact on consumer confidence and spending.

HSBC predicts the pound will plummet to $1.76 against the dollar over the next 15 months.

• Forecast for £ Sterling 2008 

When displaying time series data, it often make sense to use index numbers.

Index numbers are a simple way of making it easier to compare numbers over a period of time.

A base year is chosen (say 2000) in this year the index is set to 100. This is so it is easy to make % comparisons.

Therefore, if the general price level increase by 3.4% in the UK. The price index in 2001 would be 103.4

When comparing exchange rates it is often advantageous to use index numbers. For example, currencies can be quite hard to compare. But, when converted into index numbers it is easier to see relative changes of currencies.

Economist Commodity Price Index

2000=100

Dec 18th 2007 

• Dollar Price Index = 217
• Dollar price index metals = 237
• Sterling Index = 163
• Euro Index = 139

These index numbers show that the price of commodities has been increasing throughout the world. The dollar price of commodities has increased more because of the weakness of the dollar.

More on Index numbers 

Evaluate the economic implications for the global economy of falling dolla ? (30)

The US dollar has fallen significantly in 2007. This follows several years of continuing dollar weakness. With no seeming end in sight for the falling dollar, it is a good question to ask the economic implications for other countries.

1. US exports become cheaper more expensive. Therefore there is an increase in demand for US exports. This helps boost US AD

2. US consumers find Imports more expensive. Therefore there will be a fall in demand for imported goods. This could lead to lower growth in other countries, especially those who rely on exports to US, such as China. Note: US is the world’s biggest importer. Therefore, if US consumers reduce their imports there will be a considerable impact on other countries. However, the impact may be less than it was due to the rise in Indian and Chinese consumer spending.

Continue reading →

Readers Questions – Explain how exchange rates are determined ? (20)

Exchange Rates are determined by supply and demand side factors. For example, Increased demand for sterling will cause an appreciation in the Sterling exchange rate. These are some of the most significant factors in exchange rate determination:

1. Interest Rates.

If interest rates increase in the US then it becomes relatively more attractive to save money in US banks and in US bonds. Therefore, there is higher demand for US dollars (to be able to buy the securities). This causes an appreciation. – It is known as hot money flows.

2. Relative inflation Rates.

If US inflation was to become higher than other countries, US goods would become less competitive. Therefore, there would be less demand for US goods and US dollars, causing a depreciation.  General productivity and competitiveness will also have an influence on the exchange rate.

Continue reading →

See also: Chinese Economy 2008 

For many years the Chinese Yuan was tied to the dollar, however in July 2005 the yuan was finally allowed to break away from the dollar. However, unlike most other currencies, the Chinese government still try to influence the level of the Yuan. They have tried to keep the value of the Yuan low, to enable Chinese exports to remain competitive. Chinese record growth is due mainly to its exporting sector. The Chinese government fear that if the Yuan is allowed to become too strong, growth will slow causing unemployment to increase.

As a consequence of the undervalued Yuan, China has one of the world’s biggest current account surpluses (10% of GDP) (surplus = value of exports > value of imports)

As of November 9th, the Yuan appreciated to 7.4108 versus the dollar

The Chinese Yuan has appreciated by a small amount since 2005

Graph to show last 5 years Dollar vs Chinese Yuan (remenbi)

Continue reading →

Examine Three ways manufactures may respond to a strong pound

1. Increase productivity and Efficiency.

To remain competitive, firms need to try and cut costs so that they do not have to increase prices in other countries. However, they may already by as efficient as they can. Also productivity improvements may take a long time to occur.

2. Do Nothing.

Demand may be inelastic for UK exporters. Also the strong pound may only be a temporary effect. Therefore, there is no need to change anything. However, if the pound remains strong for a long time it will cause problems in the future. Also demand for goods often becomes more elastic over time.

3. Diversify into producing different goods.

UK exporters could start producing goods which are more inelastic (higher value, less competition). Or they could concentrate more on domestic markets.However, domestic markets may be limited and diversification will require costly intervention.

Forecasts for Canadian Dollar

With the Canadian dollar reaching a 130 year high, (Canadian Dollar reaches highest level since 1800 – Reuters) many are asking when the loonies upward momentum will end.

The strength of the Canadian dollar is being pushed by several factors:

Strong price of commodities such as oil, and precious metals. – With a booming Chinese economy, commodity prices are likely to continue being high. This will provide a long term underpinning of the Canadian dollar. If the world economy does enter recession, we can expect to see a slow down in commodity price growth, however, at the moment that is unlikely. The Chinese and Indian economies will take any slack from a weaker US economy.

The Weakness of the US dollar and economy. Underlying weaknesses in the US dollar are the main reason behind the strength of the loonie. Worries over the future of the US economy stem, in large part, from the housing market bust. If the US economy does slide into recession, this would lead to a further fall in US interest rates and therefore, cause a further deterioration in the value of the US dollar. However, despite what the doom mongers predict, the US is not heading towards an imminent collapse. Economic Growth in the Summer, posted a rather unexpected 3.9% – Whilst this is likely to moderate in the future, it is hardly an indication of imminent recession that so many people predict.

Speculation. This is the unknown quantity behind the rise of the Canadian dollar. The meteoric rise of the loonie, is encouraging some speculators to cash in on its rising value. This could lead to a bubble effect, with the potential for a future fall. Personally, I feel that at the moment most of the loonie’s rise is due to economic fundamentals. However, if the loonie keeps rising above its current value, it may be due to an increasing speculative effect.

See also:

• Forecast for Canadian US Dollar

• Canadian Dollar Chaos at Amazon.com
  
• Canadian Dollar at Bank of Canada

Q. Is A Strong Canadian Dollar A Good Thing?

This is an interesting question. The effects of an appreciation are good for some aspects of the Canadian economy, but, create problems for Canadian exporters.

• The real winners are Canadian consumers who are able to buy US goods at a much cheaper price. US border towns are reporting booming trade as Canadians make the short trip across the border to buy more goods.
• example: Disney World trip: Oct 2006 cost C$3,839. In Oct 2007, the same holiday would cost C$3,428
• Steak dinner in Detroit : Oct 2006 cost C$129. In Oct 2007 C$107
• The real losers are Canadian exporters and the Canadian tourism industry. The appreciation makes Canadian goods and services appear more expensive to US consumers.
• Exporters are seeing their profit margins squeezed as the US price of their exports increase. There is only so much that profit margins can be reduced and so most exporters have been forced to raise their price.

However, it is worth noting not everything is doom and gloom.

• Exporting to non US countries is mainly unaffected. The strength of the loonie is mainly against the US dollar and not the EURO and Yen. Unfortunately, most of the Canadian trade is with the US.
• The effect of a strong loonie, depends on the price elasticity of demand. If demand is inelastic then a strong dollar will only cause a small % fall in demand. It is worth remembering that part of the loonie’s strength is due to the strong demand for Raw materials. Demand for these exports is very inelastic