Outlook for Dollar

After displaying remarkable resilience since the economy plunged into recession, analysts are now suggesting that the underlying economic fundamentals will push the dollar lower as technical factors come to an end.

The global recession cause a technical increase in demand for dollar as people looked to hold more cash and less currency and securities from emerging economies.

However, the dollar could now be facing a decline in 2009. Due to:

• Large current account deficit causing outflow of money from US. Although deficit has reduced, capital flows are drying up in global climate.
• Interest rate cuts. US interest rates are heading for 0% as the US experience consumer price deflation for second month in row.
• Large rise in public sector debt and increase in money supply to finance it.
• Loss of confidence in US economy.

US dollar predictions 2009

The UK Economy in Crisis

Guest Article:

Mr Micawber for Prime Minister

What the Dickens

So the world economy has plunged into recession or depression as a result of over borrowing, toxic debt, unsustainable mortgages and blind panic. So what is Gordon Browns chosen route for the next 3 years a great spending splurge by reducing taxes and glad handing more give-aways than Father Christmas.

Give Aways

• The British gold reserves were sold (almost given way) at the bottom of the market. Gold rocketed in price after Gordon’s munificence.
• Off the balance sheet borrowing, of the sort that brought down Enron and others, has been a staple ploy of Gordon. PFI must mean potentially flaky investments and taxes for years to come.
• ‘Selling’ Inland Revenue buildings to a tax have based company mmm makes sense to Gordon!
• Northern Rock was baled out at a cost of unknown amounts
• Banks guarantees were given to all in sundry and reinvestment capital has been provided.

With this sort of liabilities to fund the national debt was going to grow exponentially and no one can put a total value on the exposure. Great protection of the nations wealth that seems to be. Perhaps large companies were right when they started leaving these shores for lower tax economies.

Toxic Politic

What solutions did we get yesterday.

• A cut in VAT when Ireland increased there rates of VAT perhaps that was to reduce the value of frauds as only 15% will now be creamed off by the fraudsters.
• A shuffle of the chairs on the deck, currying short term favour by putting money in the pockets of those struggling to repay credit card debts built up over the last few years.
• Gordon fails to recognise the party is over – we are over spent – he is over spent – his political future is spent and Charles Dickens spent his time on a futile story of Mr Micawber.

Conclusion

Do not vote conservative at the next election – I wouldn’t wish this can of worms on anyone

UK in Exchange Rate Mechanism - ERM

Example of

• In the late 80s, inflation in the UK was a problem; it was increasing above 10% following the Lawson Boom.
• Therefore, the government decided to join the ERM, a semi fixed exchange rate between UK and German D Mark.
• However, many now feel the UK entered at a rate which is too high.
• The high inflation made the UK less competitive reducing demand for sterling. Also as the economy was going into recession, Sterling became weaker. Investors were selling Pounds; Therefore, the government had to keep intervening to protect the value of the exchange rate. This involved buying pounds on the foreign exchange markets and increasing interest rates.
  
• However, because the economy was in recession, high interest rates made it worse. It led to record levels of home repossessions and house prices collapsed. On of 16 September 1992, the government tried raising interest rates to 15% in a last ditch attempt to save the value of the pound.
  
• But, the market correctly predicted the government was bluffing and could not keep interest rates that high. Speculators like George Soros made over £1 billion, selling pounds to the UK Government. People kept selling and at the end of the day the government gave into the inevitable and devalued the pound. This allowed interest rates to come down and the economy recovered.

• ERM at BBC

Economic Downturn definition

An economic downturn suggest the economy is entering into recession. A recession is a period of negative economic growth with falling output and rising unemployment. The official definition of a recession is - negative economic growth for 2 consecutive quarters.

The definition of an economic downturn is less strict. For example, many felt we were in an economic downturn even with positive growth. This was because the growth rate was slowing down, house prices were falling and people could see the economic cycle and shifted from a boom period and we were heading towards bust.

To define an economic downturn it is useful to mention some of the main features of an economic downturn:

• Negative or very low economic growth
• Rising unemployment
• Falling asset prices - shares and house prices
• Low confidence and falling investment
• Rising spare capacity
• Increasing government borrowing

Economic Meltdown 2009?

The events of 2008 have proved worse than the predictions of most economists. The near paralysis in the banking system has paralysed consumer and financial confidence leading to a sharp slowdown in growth and rising unemployment.

The prospects of a meltdown in economic fortunes for 2009 depend upon.

• How many more bad debts are there to write off? With house prices falling and rising unemployment pushing more into mortgage default, banks are still having to write off bad debts. Falling house prices only compound these problems.
• Unwinding of credit default swaps and other derivatives markets. There is over $60 trillion worth of credit default swaps. There is a concern that this unregulated financial instrument could cause problems as those who bought the default swaps are unable to actually repay them creating a ripple throughout the global economy
• Will Monetary Policy actually work? Central banks are rushing to cut interest rates. US rates are already 1%, they could go to zero. But, the experience of the Japanese is that 0% interest rates don't necessarily work in boosting growth when there is very low confidence and deflation
• Dollar Collapse? The dollar has held up well in recent months as investors flee emerging markets and seek the relative safety of the US economy. But, with US national debt increasing towards 70% of GDP, the Federal reserve is effectively printing more money. This could lead to inflationary pressures and a devaluation of the dollar. A devaluation of the dollar would effect the global economy as American spending falls even more.

There is hope that the recession will prove relatively shortlived. House prices in the US may be reaching near to the bottom. Cuts in rates should help homeowners. As long as the banking sector can regain its liquidity and willingness to lend we should avoid an economic meltdown. But if the financial crisis worsens and governments are unable to bail out the banks then we could see a serious depression.

• Economic crisis explained

Outlook for UK Economy

The UK economy enters 2009, with its worst economic outlook since the early 1980s.

The economy is in recession, with growth falling 0.5% in the last quarter

• Unemployment is on the rise and is forecast to keep rising well into 2010
• Government borrowing and National debt is increasing as the effects of the recession lead to lower tax revenues. This could lead to higher tax rates in the future.
• Pound Sterling is falling as the prospect of significantly lower interest rates cause investors to leave the pound.
• Housing Market still in decline as lack of mortgages causes very low level of property transactions.
• Saving ratios likely to rise as low consumer confidence encourages people to save rather than spend.
  

• The case for lower interest rates in UK
  

Yen Carry Trade Over

• The Yen Carry trade refers to how investors have been borrowing in Japanese currency (at very low interest rates) and then using this money to invest oversees e.g. in US, Europe and emerging economies.
• This enabled investors to benefit from the difference between Japanese interest rates and other interest rates.
• As well as the Yen Carry Trade, Japanese savers used their extensive domestic savings to invest oversees and benefit from higher interest rates oversees.

However, the Yen Carry Trade is coming to an end with devasting effects for the global economy. The Yen Carry Trade is over because:

1. Global recession causing slower growth in Europe and US
2. Lower growth leads to lower interest rates, reducing the difference between Japanese and American rates.
3. Appreciation in the Yen. Appreciation in the Yen means it is risky to borrow in Japan and invest oversees as the appreciating Yen, will make it difficult to pay back your Yen Loans.
4. Currency uncertainty. The Yen Carry Trade requires stable exchange rates, but, this is not occuring with the financial crisis.
5. People want to sell their foreign assets and pay back their Japanese loans.
6. Japanese savers are returning their money to Japan.

The forecast for the Yen is for the Yen to keep appreciating.

• Effects of Yen Carry Trade being over

The Impact of Falling Dollar in Long Run and Long Run

If the dollar fell, which it could do next year. This would be the economic impact.

• In the short term, a depreciation in the dollar makes exports cheaper and imports more expensive therefore there is a boost to aggregate demand (X-M) Therefore, this boost in exports is likely to improve economic growth.
• However, a depreciation doesn't guarantee long term economic growth. A depreciation does nothing to increase productive capacity. It is a reflection that the economy is becoming less competitive.
• Also a depreciation can cause inflation. This is for 3 reasons.

1. Firstly aggregate demand will increase (potential for excess demand in economy)
2. Secondly, the price of imported goods will be higher. (imported inflation)
3. Thirdly, firms may have less incentive to cut costs.

• Therefore, it is argued a long term depreciation causes the economy to become less competitive.
• A depreciation should help the trade balance. Exports increase faster than imports. However, the impact of a depreciation depends upon
• the elasticity of demand. If demand for exports is inelastic then a cheaper.
• It becomes more difficult to attract foreign capital flows. For example, the US have been financing their National debt by attracting foreigners to buy. But, with dollar depreciating this makes a bad investment. Therefore, it is more difficult to finance national debt. This will lead to either higher interest rates or inflation.

Will Monetary Policy Work

Monetary policy tries to control inflation and economic growth by changing interest rates. However, changing interest rates may be ineffective in influencing economic growth. This is because:

1 Time Lag. It can take upto 18 months for changes in interest rates to effect the economy. This is because people do not make decisions about borrowing straight away. If you have an investment project started you will finish it and not stop just because interest rates have gone up.

2. It depends who you are. E.g. Savers may spend more because they get higher interest payments. However, borrowers will be worse off. If a country has a low savings ratio then higher rates will have a big effect in reducing spending.

3. It depends on other factors affecting the economy. For example, if consumer confidence is very low, higher interest rates may be ineffective in reducing demand.

4. Monetary Policy can only target one thing at a time. For example, if there is cost push inflation, we get higher inflation and lower economic growth. Therefore, monetary policy cannot solve both at once. Supply side hocks make monetary policy quite difficult.

5. The MPC only target inflation therefore they may ignore other problems such as a boom and bust in the housing market.

6. The MPC may have poor information about the state of the economy. e.g. in early 2008 the MPC were predicting high growth and so kept interest rates high. However, growth was much worse than predicted

7. Depends on credibility of monetary policy. If the public have confidence in the Central Bank. If people expect the inflation target to be met, then monetary policy becomes more effective. Arguably, an independent central bank has more credibility than the government.

Why Dollar has been Declining in Value since 2001

The dollar has been falling for various reasons including:

1. Decline in US Competitiveness. US has been losing comparative advantage and becoming more uncompetitive especially in manufacturing industries such as automobile industry. Therefore, there is relatively less demand for the US Dollar.
2. Current Account Deficit. Consumer spending has been rising. This has been financed by a lower savings ratio and higher borrowing. Therefore Americans have increased the demand for imports this causes increased supply of dollars. In recent years it has become more difficult for the US to finance the current account deficit through capital flows. Therefore, the depreciating dollar becomes inevitable. US Current account deficit reached 6.5% GDP in 2006, it is now just under 5%.
3. Investors less willing to buy US Securities. The US was once the strongest economy. But, increasingly people are becoming more sceptical about the state of the US economy - large national debt, subprime mortgage crisis, credit crunch, recession. Also the Euro offers an alternative for Central Banks to hold their foreign reserves.
4. Interest rates in the US have been lower than Europe. Therefore, there is less demand for hot money flows. Because US interest rates are lower.
5. Political Problems make US dollar less attractive. E.g. Iran wants to price oil reserves in Euros.

Why has Dollar has recovered in past few months?

Hedge funds have been selling investments in emerging economies. There is a fear of a meltdown in emerging economies like Hungary, Argentina, India. Therefore, hedge funds have sold these investments and withdrawn money from these vulnerable economies. The result has been an appreciation in the dollar because the investment trusts

• Forecasts for dollar