And I will never understand foreign currency

Which I’m ashamed of, because my father was an expert on the subject. He’s gone now, so I have to turn to readers for help. I understand, I think, how China can peg the value of the yuan the dollar and thus fix its rate of exchange, but what does it do to make the rate flexible? How does that work?

If anyone wants to write a foreign currency guide for dummies I’d sure appreciate it, and I’ll bet I have other readers as clueless as I am.

16 Comments

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16 responses to “And I will never understand foreign currency

  1. HG

    They send some of the dollars they have been holding back out into the world. They take yuan back in exchange for the dollars and destroy the yuan in question. More of our currency outstanding, less of theirs. All else equal, Greenwich house prices go up (price = number of dollars outstanding divided by number of houses).

  2. Retired IB'er

    Anyone seen an analysis that compares the benefits to US exports of increasing Yuan versus the increase in cost of imports from China based upon more expensive Yuan?

    I would have thought that cost of imports due to a rising Yuan, given so much of what US consumes is now made in China, would offset through higher consumer inflation any gains from increased exports due to cheaper $ compared to Yuan.

    Inflation leads to higher interest rates, which hurts US economy… well, you get the point.

  3. Anonymous

    Have heard conflicting analyses on this issue from similarly successful macro hedgies

    Some of complexities of analysis include: global deleveraging underway; risk of double-dip recession in US/Germany/Japan; inflation exported out of China into a deflationary US/Germany/Japan; China’s own RE bubble; Germany/Japan export heavily to China; US-based global cos. (consider Apple) may do R&D in CA, build stuff in China using Chinese, Taiwanese, Korean and Japanese-made components, sell ~40% of stuff in RoW, many of sales at stores in NYC or CA are to tourists from EU/Asia, use both FX hedge contracts and have natural FX hedges in their global ops, keep much of their multi-$Bn cash holdings in RoW to avoid US taxes, and have largely US-based shareholders, etc etc

    Have a lot of respect for the macro guys who can both figure this globalized, interconnected, virtualized stuff out and, more importantly, place profitable bets….we live in rather interesting times for macro guys after a quiet decade or so

  4. HG

    IB’er, I haven’t seen the analysis you referenced, but I agree it is basically the key to everything. My brief post earlier this morning was a little flippant at the end (house prices go up) and also deliberately over-simplified because forex questions make my head hurt. My vague belief is that you are right that there are some offsetting negatives for the US economy. I am guessing the right answer is that US GDP (the pie) doesn’t get any bigger but the pie gets split differently. Maybe this helps the global citizens who live in Greenwich, have net savings (provided they are not in US$ cash or US$ bonds) and earn more than they spend, but hurts the citizens of Nowhere, Indiana who have been spending more than they earn and financing the difference with an indirect loan from China’s central bank.

  5. real amercian

    In the middle of the World Cup 2010, (one without China involve) China decided to stole the show and announces that is has decided to “further reform the exchange rate forming mechanism”… and… “enhance the exchange rate flexibility…” effectively, depegging the CNY. Highly political driven move it seems as it comes right before the G20 meeting next week.

    It will be a gradual process… The appreciation will be well managed. PBOC will not announce a composition of basket or detail on manage float regime. No adjustment in daily trading band of +/- 0.5% vs USD. This will be very much like July 2005 where CNY gradually appreciate 1% a month for 3 years until the middle of 2008. The 14 year low on USDCNY lies at 6.8169 on 7/18/2008, 2-months before Lehman went bust, -0.13% away from last CNY px on last Friday. Our China economist – Tao Wang – maintains her call for USDCNY at 6.20 by the end of 2011.

    While CNY will move only gradually, stock market will react strongly in the short run. US-Debt-Ridden Chinese Airline stocks will do exceptionally well. Iron-Ore-Importers like Angang Steel will get wider margin so stock should see some short squeeze. Speculative money will choose stock market or property to park money. A-shs Quota, which is already tight, will get even tighter! .. Short term frenzy should continue for a few days or even weeks. Question is, can the positive of CNY depeg takes attention away from Europe and its sovereign debt issues that’s threatening to drag us all into another financial meltdown.

    Our China strategist – John Tang – believes this is NOT a big catalyst. According to John, “ history tells us that in the early part of an RMB reval would help offshore Chinese equities, but a multi-year appreciation would force invetors to focus on the negatives such as weaker exports, rising unemployment and capital spill-over into China.”

    This week’s price action will be exciting to watch. In May, MXASJ fell as much as -14.5% at one point on Euro’s crisis and concern over China’s slowdown. Later in May, China was plaqued with suicidal workers and protesters going on strike at factories. What these suicides’ demand weren’t so clear but at the end, they got away with higher wages. In June, Maket rallies on thin volume, making last week, the best performing week for equity market globally in 6 months. Why the rally? Nobody really knows but short covering seems to be the scapegoat for the time being. Now, stronger currency risk derailing China’s export recovery… Is depegging the CNY good or bad ? … Market will tell us this week if this is good or bad.

  6. out looking in

    I wouldn’t worry Chris- it’s mostly rhetoric. The time they will truly float the yuan is when they believe it will devalue and they need the boost for exports…and don’t be ashamed, because more than half of all currency analysts suck (sorry- they are worse than that)

  7. out looking in

    and anon- if you think it has been a quite decade for macro guys, you have stolen IB’ers top shelf scotch!

  8. Supply and Demand would make the currency rise and fall in a free market.

    Governments can ‘peg’ their currency to another currency if they want. That Government has to watch the exchange rate between their currency and the pegged currency very closely.

    For instant if you thought your dollar was worth than 1.20 euro at the local exchange you dollar would have a rising value. So to get a peg you must be able to influence that decsion either way. Governments can hold the peg in several ways

    The national bank of the government doing the pegging must hold large reserves of the foreign currency to mitigate changes in supply and demand. If a sudden demand for a currency were to drive up the exchange rate, the national bank would have to release enough of that currency into the market to meet the demand. They can also buy up currency if low demand is lowering exchange rates.

    The government (Or treasury) can flood the market with currency via banks as low interest loans. Thus flooding the market with currency as bankers make high risk investments, making currency easier to come by for workers, money becomes easy to get, the value goes down as a result.

    The government can do the opposite, by withholding currency they can dry up the supply there by increasin the value.

    If the government stops doing this, the currency will immediately fluctuate and will no longer be pegged

  9. Old School Grump

    ?? Just went to this post on my iPhone, and right at the top of the text portion is a small, scrolling, all-text ad about Forex trading from OptionXpress. First time I’ve seen an ad in this blog. Make sure you’re getting paid!

  10. Anonymous

    fact remains that no nation has ever devalued its way to prosperity. a weak dollar is no solution.

  11. Priapus

    Dear retired IB er
    You are correct. Classic example of ” be careful for what you wish”. The jackasses in Washington strong arm china into this then will wonder why US consumers face inflation and US vendors of products face massive margin squeezes. We deserve what we get for electing such cretins.

  12. Cos Cobber

    Priapus, yes our cost of inputs will rise with a rising yuan, but isnt this offset somewhat by increased exports of american made goods with a high content of american labor/materials?

    Anywho, I’ve never been able to understand how we are going to cure our trade imbalance without i) foreign currencies becoming stronger and ii) the US getting tougher on nations that use bureacracy to stiffle our exports (ie Japan).

    I agree though, a truly week currency certainly wont bring prosperity either.

  13. Priapus

    Cos Cobber
    We export food and chemicals to China. Ttttthat’s all folks. We now import everything else, including inflation.

  14. Cos Cobber

    Priapus, I understand that….but a remarkable thing started to happen when our currency went soft a couple years back, right before the bottom really fell out due to the credit crisis. Value added products such as big machinary (catepillar, terex), to some extent autos (volkswagon has been toying with a major factory for audi and vw in chattanooga, tn) started to finally gain some ground in exports.

    Sure the devaluing of our currency will hurt for many products we have grown to enjoy at cheap prices (electronics, clothes) but perhaps it will help put a portion of that solid 20% of our society that is unemployed and underemployed to work.

    I just dont see how 20+ years of substantive trade balances doesnt come home to roost in a big and ugly way. The only way to balance out ship is too let our currency slip (some, not a ton) to the asian tigers. Doing so also forces those export hogs to think harder about holding our currency (via t-bills) and actually buying some sort of good or service (heaven sake!).

    Anywho, there is plenty I still need to learn in this area, so hit me with corrections.

  15. Priapus

    Yes, a remarkable thing indeed. The dollar declined 40pct vis the basket in the last decade. Remarkably gold went up 4x and a latte in Paris cost 15 dollars. So, yes I’m sure some union dope should still be making remarkable products so we can import inflation and vacation on the gulf coast only.