Reply #1: WrapUp by Rob Kirby

[ozymandius]

CURRENCY CONUNDRUMS

In light of much of what has been going on – from a macro economic perspective – I felt it might be appropriate to review some of the fundamental factors that affect a currency’s worth. As we can see below,



the U.S. dollar has been strengthening from roughly the Spring of 2005. Let’s examine some of the fundamentals to ascertain whether or not this rise in the dollar’s value has been warranted.

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The responsibility of administering the monetary policy in the U.S. falls on the shoulders of the Federal Reserve. The tools at the Fed’s disposal to carry out this task are most commonly thought to be interest rates. While interest rates are indeed a powerful ‘lever’ in determining demand for credit – and thus the economy’s fortunes – it is not the only tool the Fed has at its disposal.

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The Fed has another powerful tool in its bag – called Open Market Operations – that enable the Fed to rapidly inject or withdraw vast amounts of money into the banking system via repos (short term borrowing – or purchase and resale - of securities from the market place) or matched sales (short term selling and subsequent repurchase) of securities through member banks and investment houses. This powerful tool (open market operations), in effect, allows the Fed to be seen to be acting with constraint (reigning in inflation) in the economy whilst simultaneously opening the monetary or liquidity spigots (doing exactly the opposite) in terms of injecting ‘short term’ cash in the banking system. Needless to say, over the past 12 Fed hikes in interest rates (dating back to June 04) – which have seen the Fed raise rates from an historic low 1% to the current 4% - virtually all open market operations undertaken by the Fed have been through the repo (monetary aggregate add) mechanism. Interesting, in my opinion, from a group that preaches how vigilant they are on preventing inflation.

So, there you have it folks, on the fiscal front – an accident looking for a place to happen and on the monetary front – a central bank (the Fed) that seems (by empirical observation) to want to have it both ways. Many would argue that this is decisively fundamentally negative, yet the dollar appreciates?

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