International Finance the Reasons on Research Paper

  • Length: 9 pages
  • Sources: 8
  • Subject: Economics
  • Type: Research Paper
  • Paper: #33612179

Excerpt from Research Paper :

This process of investors selling U.S. assets may have already begun, as the dollar's value has declined significantly in the past year (Bivens, 2003).

b) Does it appear that the Asian currencies move in the same direction relative to the dollar? Explain.

A new study released from the Peterson Institute for International Economics concluded that the dollar is still considerably overvalued against a number of Asian currencies, most significantly the Chinese renminbi and the Japanese yen. It is thought that the renminbi needs to go up by about 30% against the dollar and the yen should strengthen by about 20%. A number of other Asian currencies also need to appreciate substantially so the desired increases amount to much less on a trade-weighted average basis which is under 20% for the renminbi and only about 5% for the yen (Lien, 2009).

This study also found that the euro and the pound are now overrated on average. They have not gone over the dollar a lot and the depreciation in their effective exchange rates should come largely from the appreciations of a number of Asian currencies. Generally, the dollar is now overvalued by less than 10%. It has gone down by almost 25% since early 2002. The U.S. current account deficit has improved by about $80 billion, falling from about 6% of GDP to about 5%. This gain would have been larger if it had not been for the sharp rise in the price of oil imports, and the reduction in the real deficit as incorporated in the GDP accounts (Lien, 2009).

The Asian currencies that should appreciate most are the Singapore dollar, the Chinese renminbi, the Malaysian ringgit, the New Taiwan dollar, and the Japanese yen. The Korean won is the only Asian currency estimated to be overvalued, despite which it would need to appreciate against the dollar (but not on a trade-weighted average basis) as part of the needed multilateral realignment (Lien, 2009).

Dollar depreciation will have different effects on economies with floating exchange rates and those with currencies pegged to the dollar. Most DMCs maintain floating exchange rates, under which authorities normally do not intervene in the foreign exchange market and the currency is left to react to market signals. Currencies with floating exchange rates will appreciate in response to dollar depreciation. A few DMCs peg their currencies to the U.S. dollar. Hong Kong, China formally pegs the Hong Kong dollar to the U.S. dollar. The People's Republic of China (PRC) maintains a de facto peg to the U.S. dollar. The Malaysian currency is also kept within a very narrow range of exchange rate with the dollar. The pegged exchange rate arrangement requires authorities to intervene in the foreign exchange market to maintain the fixed exchange rate. They will have to buy domestic currency when it is in excess supply and sell it when it is in excess demand to avoid a currency depreciation or appreciation. When the dollar depreciates, currencies pegged to the dollar will also depreciate against other currencies.

Different policy regimes mean DMC currency changes will vary relative to the dollar. The effect of dollar depreciation will be different for economies with floating and pegged exchange rates (Lien, 2009).

Much has been written about the suitability of technical analysis for trading in the currency markets. While this is undoubtedly true, it can leave traders, particularly those new to the currency markets, with the impression that all technical tools are equally applicable to all major currency pairs. Perhaps most dangerous from the standpoint of profitability, it can also seduce traders into searching for the proverbial silver bullet: that magic technical tool or study that works for all currency pairs, all the time. However, anyone who has traded forex for any length of time will recognize that, for example, dollar/Yen (USD/JPY) and dollar/Swiss (USD/CHF) trade in distinctly different fashions. Why, then, should a one-size-fits-all technical approach be expected to produce steady trading results? Instead, traders are more likely to experience improved results if they recognize the differences between the major currency pairs and employ different technical strategies to them. This article will explore some of the differences between the major currency pairs and suggest technical approaches that are best suited to each pair's behavioral tendencies (Dolan, 2010).

By far the most actively traded currency pair is euro/dollar (EUR/USD), accounting for 28% of daily global volume in the most recent Bank for International Settlements (BIS) survey of currency market activity. EUR/USD receives further interest from volume generated by the Euro-crosses and this interest tends to be contrary to the underlying U.S. dollar direction. For example, in a U.S. dollar-negative environment, the Euro will have an underlying bid stemming from overall U.S. dollar selling. However, less liquid dollar pairs will be sold through the more liquid Euro crosses, in this case resulting in EUR/CHF selling, which introduces a Euro offer into the EUR/USD market (Dolan, 2010).

This two-way interest tends to slow Euro movements relative to other major dollar pairs and makes it an attractive market for short-term traders, who can exploit "backing and filling." On the other hand, this depth of liquidity also means EUR/USD tends to experience prolonged, seemingly inconclusive tests of technical levels, whether generated by trendline analysis or Fibonacci/Elliott wave calculations. This suggests breakout traders need to allow for a greater margin of error: 20-30 pips. A pip is the smallest increment in which a foreign currency can trade with respect to identifying breaks of technical levels (Dolan, 2010).

The next most actively traded currency pair is USD/JPY, which accounted for 17% of daily global volume in the 2004 BIS survey of currency market turnover. USD/JPY has traditionally been the most politically sensitive currency pair, with successive U.S. governments using the exchange rate as a lever in trade negotiations with Japan. While China has recently replaced Japan as the Asian market evoking U.S. trade tensions, USD/JPY still acts as a regional currency proxy for China and other less-liquid, highly regulated Asian currencies. In this sense, USD/JPY is frequently prone to extended trending periods as trade or regional political themes play out (Dolan, 2010).

For day-to-day trading, however, the most significant feature of USD/JPY is the heavy influence exerted by Japanese institutional investors and asset managers. Due to a culture of intra-Japanese collegiality, including extensive position and strategy information-sharing, Japanese asset managers frequently act in the same direction on the yen in the currency market. In concrete terms, this frequently manifests itself in clusters of orders at similar price or technical levels, which then reinforce those levels as points of support or resistance. Once these levels are breached, similar clusters of stop loss orders are frequently just behind, which in turn fuel the breakout. Also, as the Japanese investment community moves en masse into a particular trade, they tend to drive the market away from themselves for periods of time, all the while adjusting their orders to the new price levels, for instance raising limit buy orders as the price rises.

An alternate tactic frequently employed by Japanese asset managers is to stagger orders to take advantage of any short-term reversals in the direction of the larger trend. If USD/JPY is at 115.00 and trending higher, USD/JPY buying orders would be placed at random price points, such as 114.75, 114.50, 114.25 and 114.00, in order to take advantage of any pullback in the broader trend. This also helps explain why USD/JPY frequently encounters support or resistance at numerically round levels, even though there may be no other matching technical significance (Dolan, 2010).

China's emergence as an economic superpower will escalate the demand for the Asian giant's currency, which is also known as the people's money. Beijing will eventually permit the Yuan to trade freely on foreign-exchange markets, discarding the current system under which the government controls the currency's value. As China moves in this direction, other large emerging economies will presumably gradually move in the same direction and the end result will be something approximating to today's Western monetary system. Under such a system, the renminbi, dollar and euro would all form the linchpin of the world's currency markets (Patalon, 2010).

Of the four BRIC countries, China is thought to be likely to have the biggest impact in the near-term. Sometime this year, in fact, the Asian giant is likely to leap over Japan to become the world's No. 2 economy behind the United States. In the next 10 years, China is likely to approach the U.S. economy is size. The Chatham House report stated that the dollar-based monetary system is no longer sufficient for a larger and more integrated world economy. Well-known developing economies are increasingly demanding to be included in any multilateral dialogue that aims to shape the new economic order (Patalon, 2010).

References

Amadeo, Kimberly. (2010). Value of the U.S. Dollar. Retrieved May 30, 2010, from About Web

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