Foreign Currency Headwinds Buoy Dollar for Now

Monday, 04 Mar 2013 07:39 AM

By Sean Hyman

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There’s been a very temporary rise in the value of the dollar lately, but it hasn’t been because of strengthening fundamentals in the greenback.

You see, currencies trade in pairs. In other words, their value is determined when comparing themselves against one another.

So picture a seesaw. On one side you have the world’s reserve currency (U.S. dollar) and on the other side, you have other major currencies of the world (euro, pound, yen, Swiss franc, Australian, Canadian and New Zealand dollars, etc.)

Much of the time, the greenback is falling and these other foreign currencies are rising as the buck falls against them.

But in the very near term, the U.S. dollar has gotten a temporary boost because of the reverse scenario … temporary headwinds that some major currencies are facing. Let’s take a look at some of them.

Right now, in Italy, they’ve not had a clear-cut election. That’s causing some uncertainty there because investors don’t know which direction the Italian government will go in because it doesn’t have a leader yet and, therefore, there’s no way to know the future leanings that the government will have as a result.

Uncertainties like this can always weigh heavily upon a currency, and that’s exactly what happened in the near term for Italy’s currency, the euro.

The euro has been called the anti-dollar because when money is flowing away from the buck, one of the first places money runs to is the next most liquid currency in the world — the euro. However, the reverse is also true too. When money runs away from the euro, one of the first places it will run to is the greenback.

We’re seeing that now with the uncertain outcome of the Italian election and we said it last year when the European crisis hit.

Now, the Italian election issue will be resolved in the coming weeks or months and that headwind will blow over. Once it does, the euro will begin to ascend and the dollar will continue its long-term descent.

But it’s not just the euro that’s facing near-term headwinds.

The British pound is facing headwinds for now as Moody’s just downgraded the credit rating of the United Kingdom because of its monetary stimulus to help boost their economy. Further temporary headwinds could come to the pound too if they go with the “negative interest rate” idea that they’re toying with now.

Personally, I’m a fan of the central bank using negative interest rates, which means they charge banks for deposits rather than paying them interest. What this does is it highly encourages banks to get the money lent out to business owners, etc. so that they can expand their businesses and the economy can grow.

This tactic almost ensures that banks won’t hoard the money they have, but instead will seek to avoid paying interest to the central bank by getting the money out of the bank and into the marketplace in the form of loans to people and businesses where they can earn interest.

Honestly, it wouldn’t be a bad thing if they did that here in the United States as well. Denmark is already doing it and the United Kingdom might do it. But if you want to get banks to get off of their piles of cash, this is one very effective way to do it, in my opinion.

But no doubt that in the near term, negative interest rates can end up having a negative effect on a currency. But as the economy begins to turn around as a result of increased bank lending, in the long run it would be a positive for a currency. Nonetheless, the Moody’s downgrade weighs upon the pound for now, which ends up being a temporary “dollar positive.”

If there is one country that is targeting the lowering of their currency even more than the United States, it’s Japan. They are the only major country that I know of that’s devaluing its currency at a quicker rate than us right now. We can see proof of this in the rise in the U.S. dollar to yen exchange rate, which directly compares the dollar and yen against each other.

And now that Japanese Prime Minister Shinzo Abe’s pick for the central bank has been approved, we’re almost certain to see more yen selling because both of these guys want a lower yen to attempt to boost their economy through boosting their exporter’s businesses (e.g., Toyota, Honda, Sony, Panasonic).

This slaughtering of the yen has turned into a temporary dollar positive event too. Again, nothing to do with the fundamentals of the dollar, but rather it is temporarily making the dollar the less ugly in the ugly currency contest (for now).

The Swiss continue to try to “talk down” their currency. It’s obvious they don’t want a higher franc right now because they want their franc to still seem cheap relative to the euro (because the biggest chunk of their exports of watches and chocolates go to the remainder of Europe). And the lower the euro goes, the more the Swiss are inclined to desire a lower franc, for now.

Then there’s Australia. Australia’s central bank is trying to encourage the country’s currency lower by saying that their models show that the Australian dollar is 4 percent to 15 percent overvalued. Yet, now 34 central banks now hold Aussie dollars so it’s probably not as terribly overvalued as they say. Nonetheless, they are trying to “talk down” their currency too.

Then there’s New Zealand. Now I know this tiny island country doesn’t seem like much to many of you, but they are considered to be one of the major currencies of the world.
New Zealand’s central bank is talking about the possibility of intervening in the currency market to lower the value of their currency. A strong New Zealand dollar is weighing upon their exporters right now and they are very much dependent upon exports (of things like milk, butter, etc.) and tourism, both of which could be hindered by a strong currency.

So they’re talking about intervening, which means they’d go into the currency market and sell their currency while buying up other currencies against it. They’ve done this a few times in the past. And while in the near term, they were successful, the success quickly turned into failure weeks to a couple of months afterward, every time. So this is a futile plan ultimately, but one they occasionally attempt to do.

Again, a headwind to their currency, nicknamed the kiwi, which ends up being a temporary “dollar positive.”

Now these issues are temporary and will all pass. In the end, most of these currencies are better places to be than in our dollar because the fundamentals of their countries are much better than ours here in the United States (particularly in the case of Australia and New Zealand).

Once all of this blows over, we’ll be back to the most important issues at hand, which are the massive rate at which the Federal Reserve prints money and the massive rate at which our debts are stacking up as a nation. These are NOT things that will quickly blow over and that’s why ultimately, the dollar heads lower against these currencies.

But for some more days to weeks, maybe even a couple of months, the dollar could benefit from these foreign currency negatives that are out there presently.

About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He is also the editor of Ultimate Wealth Report. Discover more by Clicking Here Now.

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