The business news brings all sorts of stories to the fore, usually with little understanding or comprehension of the basics underlying such stories. Suddenly there is a worldwide Dollar shortage that will overwhelm the Federal Reserve Bank. And the strength of the Dollar will cause superior growth in Europe as its exports become cheaper in the world market. A strong Dollar weakens job growth and the President is beset with questions. The truth of the matter is that foreign exchange is little understood outside a few economists, foreign exchange traders, and business people. By a few I mean a few thousand not two or three, but it’s a relative amount by population. Back in the old days when gold was the standard medium of exchange there was very little problem buying and selling across borders. But gold is bulky and heavy. Imagine carrying a few billion’s worth of bullion to conduct business in another country. The “carrying cost” is high as is the handling fees. Back when the Italians were the world bankers and Spain was opening up the new world, letters of credit served a vital purpose. Rather than risk carrying sacks of gold coin and ingot bars on board ships from Genoa to Cadiz, where on that journey one’s ship may be attacked by Barbary Coast pirates and the gold taken as prize money, a letter of credit did the pirate absolutely no good for it could only be used by the recipient. Score one for the good guys, if you believed the Spanish kings and princes and the Italian bankers were good guys. To my knowledge there is no Saint Cortez in the new world.
So goods and services are traded between countries and the settlement contracts, that where paying for all this trade comes in, are written and the currency or currencies specified. To give you an example, if you lived in Hungary and wanted to buy a house you might have taken out a mortgage to be repaid in Swiss Francs rather than Euros, since no foreign bank was accepting Forints, the Hungarian currency. If you had done that, you actually lost because the Swiss Franc was pegged to the Euro. This “pegging” is the government of that pegged currency dictating the value of its currency in the currency of another country or group of countries. The Chinese Yuan is pegged to the US Dollar and has for the past ten years undervalued so that China could sell to the US and Europe at cheaper prices. In a way, it is like selling below costs. The penalty is that imports cost more but when your imports are from developing countries the cost is minimal. As you with me so far? The other part of these transactions is that unless a bank in one country has a counterpart or associate branch in another country, it can only accept foreign currency if it actually has a license to deal in foreign currency. And usually here, many of the currency trades for banking purposes are made through the New Your Federal Reserve Bank. But that’s not all that happens in the world of foreign exchange. One can borrow in another currency to buy assets such as foreign government bonds. That was the Japan Yen carry trade. One could borrow funds in Japan at extremely low interest rates, sometimes as low as half a percent, and then buy US treasuries, usually short term. The difference between the cost of the funds and the returns may have been relatively small, but if one can borrow in multiple millions the one can make a nice profit. Note that the loan was taken out in Yen, converted to Dollars, then bonds were bought and sold, the Dollars were converted back to Yen. The currency accounts were settled. On the other hand, letters of credit work just as well and there is not exchange fee involved.
If you are a European bank and a client wants to borrow money for some project, perhaps the construction of a manufacturing plant in another country, you may want to hedge your risks by specifying repayment in dollars. Right now there are some 9 trillion Dollars worth of contracts in the world where the debt is specified in Dollars. This may reflect the risk that another currency has or its economic base. Understand why the popularity of the Dollar. It is the world’s reserve currency. Back when we were the undisputed king of the economies, there were more dollars spread around the world than any other currency. This was before the EMU and the creation of the Euro. For decades the Europeans complained about their countries being awash in Dollars. How did this come about? Simple, we went off the gold standards and so did everyone else. Crude oil became the new gold, although it was subject to supply and price fluctuations that made gold look as good as, well, gold. Being the reserve currency gave us new economic strength around the world but it also made us weaker. As the strongest currency imports cost more, a whole lot more. Before we went off the gold standard I use to be able to buy that great French Bordeaux wine, Chateau Latour for $25 a bottle. After we went off the gold standard I couldn’t find it for less that $100 a bottle. Of course today the price is totally out of the question. I’d have to get 100 Euros to the Dollar to be able to think of buying that wine again. Not gonna happen in my lifetime and I only got about twenty years left.
Now funny thing happened on the way to the Forex market. The Fed started doing Quantitative Easing, or giving money to banks in the hope that they would lend it to consumers. Unfortunately the consumers have pretty much exhausted their credit limits and who wants a crummy two or three percent return when one can get six or ten or how ever high with the right asset? Dear readers, that is not how you jump start an economy. Almost all economies in the world are consumer based, and usually by 60% or more. If you need people to buy more goods and services then they need more money, not the banks. If you want to stimulate the economy, then give that money to the consumer. Hell, they’re paying for it anyway through taxes. And every time QE went into effect I noticed that the Dollar dropped in price relative to the Euro. Now with the very real threat of Greece leaving the EMU and possibly the EU as well, there is real panic in the banking world. And now that Super Mario Draghi, the ECB chairman gone stupid, has started the ECB’s on QE program, buying government bonds from private banks that need the safety of government bonds that are required for many of their accounts, we see the Dollar gaining strength over the Euro. Far more people are seeing the handwriting on the wall, the EMU is doomed, the European banking system is insolvent, and the whole mess will come crashing down within two years of less. It is one thing for Germany to finally push Greece out of the Euro, but what is unforeseen at the moment is the UK leaving the EU. And well they should, for the EU is an expense, not an asset. That nanny crat state that mere adds regulation upon regulation in a never ending fashion and keeps asking for more money to run it ponzi scheme is of no real benefit to the UK. But the UK will crash and burn. Well, yes, they have borrowed themselves into the poor house, just like everyone else. So that is going to happen anyway. But if the UK pound takes a nose dive then there is a chance to re-establish many of the industries they kicked off their island. Oh, that might even create new jobs, what a thought.
Now to be fair, I only want a strong Dollar because I live in France three months every year and I love having my dollar go so much further. And perhaps I can now enjoy some of the better French wines here in the US, I won’t have to drink California stuff (it’s ok but it ain’t what I love). And by the way, China will have to do something about their dollar peg and that won’t be pretty. The economy predicted by so many fools that will surpass us is going into a nose dive of epic proportions. First you let your party officials up and down the line fudge the numbers so that you have no idea of what your economy is doing, brilliant thinking that. Then you unleash to hounds of excessive debt to buy assets beyond near future use. Then you don’t control your banking sector and now a great many of your banks are insolvent but you can’t really tell which loans will be preforming and which one because your metrics don’t work. You over build like crazy and the capacity utilization is extremely poor. Even American business isn’t that stupid. Yeah, you’re going to own the world if someone will lend you enough money. Good one.