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US dollar Vs The Euro

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					            MONEY, MONEY & MONEY

What are the advantages and disadvantages of both a
fixed exchange rate regime and a flexible exchange
rate regime?
             Mahmoud Haddad, PhD
                Professor of Finance
         College of Business and Public Affairs
             University of Tennessee-Martin
         http://www.utm.edu/staff/mhaddad/
               Email: mhaddad@utm.edu
                   +1731-881-7249
MONEY CANNOT BUY




 Chinese proverb E:\US Dollar07\Chineseproverb_1-Money.pps
ADVANTAGES OF FIXED EXCHANGE RATE SYSTEM:


  1- Reduced risk in international trade –
  By maintaining a fixed rate, buyers and sellers of goods
  internationally can agree on a price and not be subject to the
  risk of later changes in the exchange rate before contracts are
  settled. The greater certainty should help encourage
  investment.

  As businesses have the perfect knowledge that the price is
  fixed and therefore not going to change, hence they can plan
  ahead in their productions.
ADVANTAGES OF FIXED EXCHANGE RATE SYSTEM: CON



  2-Introduces discipline in economic management
  As the burden or pain of adjustment to equilibrium is thrown
  onto the domestic economy then governments have a built-in
  incentive not to follow inflationary policies. If they do, then
  unemployment and balance of payments problems are certain
  to result as the economy becomes uncompetitive.

  Inflation may have a harmful effect on the demand for exports
  and imports. To ensure that inflation is kept as low as possible
  the government is forced to take measurements, to keep
  businesses competitive in foreign markets.
ADVANTAGES OF FIXED EXCHANGE RATE SYSTEM: CON


  3-Fixed rates should eliminate destabilizing
  speculation Speculations flows can be very
  destabilizing for an economy and the incentive to
  speculate is very small when the exchange rate is
  fixed.
  In theory a fixed exchange rate should also reduce
  speculations in foreign exchange markets. But in
  reality this is not always the case as countries want to
  make speculative gains.
DISADVANTAGES OF FIXED EXCHANGE RATE SYSTEM:

 1-The government is keeping the exchange rate
 fixed by manipulating the interest rates. If the
 exchange is in danger of falling the government
 needs to increase interest rates to increase
 demand for the currency. As this would have a
 deflationary effect on the economy the demand
 might decrease and unemployment might
 increase.
DISADVANTAGES OF FIXED EXCHANGE RATE SYSTEM: CON.


  2- The government has to maintain high levels
  of foreign reserves to keep the exchange rate
  fixed as well as to instill confidence on the
  foreign exchange markets. This makes clear
  that a country is able to defend its currency by
  the buying and selling of foreign currencies.
DISADVANTAGES OF FIXED EXCHANGE RATE SYSTEM: CON.


  3-Fixing the exchange rate is not easy as there
  are many variables which are changing over
  time if the exchange rate is set wrong it might
  be hard for export companies to be competitive
  in foreign countries
DISADVANTAGES OF FIXED EXCHANGE RATE SYSTEM: CON.


  4-International disagreement might be created
  when a country sets its exchange rate on a too
  low level. (US $ vs. Chinese Renminbi),And

  5-This would make a countries export more
  competitive which might lead to a
  disagreement between countries as they might
  see it as an unfair trade advantage. Current
  account deficit
DOLLAR VS. THE EURO

 Historical rate:
  http://www.exchange-
 rates.org/history/EUR/USD/G/180

 The Shrinking Value of the Dollar:
 http://www.infoplease.com/ipa/A0001519.ht
 ml
 Rates and graphs
EXCHANGE RATE DETERMINATION

Exchange Rate Determinants:
Purchasing Power Parity (PPP)
Interest Rate Parity (IRP)
International fisher Effect
FALLING US $
 Why the dollar is falling:

 The falling value of US $ relative to most major currencies are related to the
 fundamentals of the respective economies.
      1-The US continues to accumulate deficit to finance the ongoing war,

      2- The increased uncertainty,
 The subprime crisis of the summer shook the world's confidence in certain
 kinds of U.S. financial assets--particularly the more complicated, so-called
 structured products, derivatives based on housing-market debt.
 The private demand for U.S. debt fell, which had an impact on the dollar. If
 the attractiveness of the financial assets of an economy is generating falls,
 and there's no increase in the attractiveness of other kinds of assets, the
 net effect is that there's less demand for your assets and your currency.
DOLLAR VS. THE EURO, CONTD.


    3- The rising price of oil. Oil producers are
    not holding dollar, and

    4-The falling real interest rates in the US as
    dollar denominated assets have become
    far less attractive for foreigners to hold.
DOLLAR VS. THE EURO, CONTD.

 Wednesday, December 18, 2007.
 The Federal Reserve Bank provided $20 billion in
 loans to banks as part of an unprecedented
 auction process to ease a global credit crisis and
 make sure financial institutions can keep lending
 to their customers. The interest rate on the short-
 term loans will be 4.65 percent, which is slightly
 less than the 4.75 percent the Fed charges banks
 on emergency loans through its "discount" window.
FEDERAL RESERVE ACTION
 Fed fund rate:
 The funds rate is the rate banks charge each other on overnight
 loans.
 Liquidity infusion to ease the credit problem.
 The Fed has lowered the fed fund rate three times this year.
 The most recent rate cut on Dec. 11 dropped the rate down to
 4.25%, a two-year low.
 The Fed rate affects a wide range of interest rates charged to
 people and businesses, making it the Fed's main tool for
 influencing U.S. economic activity.
IMPACT ON US ECONOMY
 There is good news bad news for different
 sector of the US economy as related to the
 falling dollar and appreciation of the Euro, yen
 and Pound.
 Good for:
 The manufacturing sector, it is very good as
 they the sector gain advantage over their
 foreign competitors. US goods are fairly very
 inexpensive to foreign buyers
IMPACT ON US ECONOMY, CONTD.

 It is good for the truism industry; travelers from
 other countries find everything relatively cheap
 in the USA.

 Bad for:
 US travelers to overseas as weak dollar does
 not buy much of foreign goods and services.
IMPACT ON US ECONOMY, CONTD.

 It is also not good for price inflation; weak
 currency is always inflationary in nature, as
 import price goes up, inducing domestic
 producers to raise their price too.

 It is not good for Americans’ self-image, the
 world largest and strongest economy.
IMPACT ON US ECONOMY, CONTD.
Whatever the long-term effect of the strong Euro
 (and the weak dollar),
 In the short run the current exchange rate could
 serve American interests,
 It helps reduce the current- account deficit,
 Europeans could help save what is expected to be
 a somber holiday shopping season, even though
 retail sales figures for November, released
 Thursday, Dec. 6, 2007 were better than
 anticipated.
IMPACT ON THE REST OF THE WORLD
 It could be a blow to the world economy as some
 central bankers worry about “currency tension,”
 and many countries move trillions of dollars out of
 their $ reserves and buy Euros instead of the
 dollar. Uncertainty= Risk.

 Europeans are worried about how expensive their
 exports are becoming for American consumers
 when priced in dollars, and how much that hurts
 European economic growth. Balance of payment.
IMPACT ON THE REST OF THE WORLD, CONTD.

 In November 2007, Mervyn King, the governor
 of the Bank of England was concerned about
 the appreciating pound and euro against the
 dollar. He stated that “the appreciation of the
 pond and euro, combined with most oil-
 producing countries and China linking their
 currencies to the dollar, creates “great currency
 tension.”
IMPACT ON THE REST OF THE WORLD, CONTD.

 The “currency tension” could hurt the dollar
 further as countries like China, which holds the
 largest reserves of American currency outside
 the United States, see their dollar reserves sink
 in value and hurry to move them to other
 currencies (euro). Currently, China is financing
 a significant share of the U.S. current account
 deficit. Will it continue???
IMPACT ON THE REST OF THE WORLD, CONTD.

 There's an increasing debate within China
 about whether the rapid increase in its dollar
 holdings continues to serve China's interest.
 However, so long as China resists more rapid
 appreciation of the renminbi [China's currency]
 versus the dollar, it's rather difficult for China to
 diversify in any meaningful way against the
 dollar.
IMPACT ON THE REST OF THE WORLD, CONTD.
 So long as China itself pegs it currency to the dollar or manages its
 currency primarily against the dollar--technically China has a crawling
 peg, and it's clear from a range of economic analysis that it's crawling
 mostly against the dollar, not against a true currency basket--then if it
 puts pressure against the dollar, it's also putting pressure against its
 own currency.
 This is a meaningful constraint on China's ability to change its
 currency portfolio.
 It is important to note that since maintaining the current value of the
 Rrenminbi versus the dollar requires China to buy a lot of dollars, not
 just hold onto its existing stock of dollars, means that keeping the
 dollar from falling and keeping the value of China's current dollar
 holdings constant, it requires China to continually increase its dollar
 exposure.
IMPACT ON THE REST OF THE WORLD, CONTD.
 Are countries in East Asia concerned that a falling dollar will hurt their exports?
 From theoretical and practical point view, Countries that peg to
 the dollar are seeing the value of their currencies fall against
 the euro and are seeing a rapid increase in their exports to
 Europe. China.
 So for many East Asian countries, the concern isn't that a fall in
 the dollar will lead to a fall in their exports. It's that economic
 weakness in the U.S. will spread to Europe, and that the
 broader reduction in global growth will lead to a reduction in
 their export growth.
IMPACT ON THE REST OF THE WORLD, CONTD.

 There are specific concerns in countries like
 India and Thailand that have let their
 currencies appreciate against the dollar and
 the renminbi--they are worried that China will
 undercut them in global markets.
 As a result, they've been resisting further
 appreciation in their currencies.
IMPACT ON THE REST OF THE WORLD, CONTD.

 An estimated $1.2 trillion in dollar holdings will
 move to other currencies over the next five years
 In May, Kuwait dropped its currency’s link to the
 dollar,
 In October, Iraq said it wanted to diversify its
 heavily dollar-dominated reserves.
 Other countries, including Qatar, have complained
 about the negative effect of the weakening dollar
 on their reserves.
REASONS FOR EXITING PEGGED EXCHANGE RATES TO FLEXIBLE REGIMES:



  The issue of exiting from fixed to flexible
  regimes lies at the junction of two rich bodies
  of literature; currency crisis and regime choice.
  The currency crisis literature falls short in
  accounting for orderly regime transitions.
  The regime choice literature, on the other hand,
  does not consider the consequences of this
  choice.
REASONS FOR EXITING PEGGED EXCHANGE RATES TO FLEXIBLE REGIMES:



  1-Increasing Trade and,
  2-Financial Integration
  Increasing trade and financial integration force
  many countries to move to more flexible
  regimes.
   Some countries exit without experiencing
  major disruption in economic activity, but
  majority of them did so in the midst of a crisis.
REASONS FOR EXITING PEGGED EXCHANGE RATES TO FLEXIBLE REGIMES:



  3- Economic stabilization
  Many developing countries were advised (IMF)
  to pursue pegged regimes in which exchange
  rate is used as a nominal anchor to enhance
  the credibility of monetary policy.
REASONS FOR EXITING PEGGED EXCHANGE RATES TO FLEXIBLE REGIMES:



  Moving to more flexible regimes once a certain
  level of economic stability is reached
  constituted the ultimate target of many (IFM)
  programs.
  Some countries managed this transition quite
  successfully; the majority has faced speculative
  attacks
CONDITIONS UNDER WHICH EXITS FROM PEGGED TO FLEXIBLE REGIMES ARE
MANAGED IN AN ORDERLY MANNER.



  Higher output growth,
  Higher private credit and
  Overvalued real exchange rate before exit,
  among others,
ECONOMIC FACTORS WHICH WILL INCREASE THE LIKELIHOOD OF EXITING IN
A DISORDERLY MANNER.



  Output and credit collapse,
  Exchange rate depreciates considerably.
  An ill-managed financial liberalization and
  macroeconomic stabilization programs seem to
  lay the seeds of instability which takes the form
  of a boom-bust cycle.
CONCLUSION
 Policy makers should but more emphasis on concerns that
 U.S. weakness may be the leading edge of a broader
 global slowdown.
 Some Asian economies, like those of China that are doing
 very well and are pegged to the dollar, should worry that
 there's a growing difference between the domestic needs
 of their own economies.
 Their own economic conditions likely call for higher
 interest rates and a stronger currency and the current
 economic and monetary policy that they're importing by
 virtue of their peg to the U.S. dollar.
CONCLUSION

 Nouriel Roubini, a professor at the Stern School
 of Business at New York University stated that
 “The current currency system is quite fragile
 and will break down as it leads to imbalances
 and capital losses” among countries with dollar
 reserves.
CONCLUSION

 Chris Munns, a lecturer at the London School
 of Economics, said it is still less clear whether
 one or several currencies will replace the dollar
 as the main reserve currency. “With the euro,
 the world has gained an alternative reserve
 currency but other currencies have also won in
 strength,” Currency diversification.
CONCLUSION
 The U.S. economy is interconnected with the world economy.

 Confidence in a currency is the greatest determinant of the real
 exchange rate (euro-dollar). Decisions are made based on
 expected future developments that may affect the currency

 At this point in time, many countries are willing to purchase a
 substantial amount of US dollar (debt) and receive a modest
 rate of return. This willingness would melt if the US continue to
 run a current-account deficit and to run-up budgetary deficits.
CONCLUSION

 Exits are more likely to be orderly when
 undertaken in favorable conditions (sound
 macroeconomics, adequate banking systems
 and a period of capital inflows.
 A study by Asici et al. (2007), found that the macroeconomic
 discipline represented by budget and current account balance
 does not seem to be important in determining the type of exit.
 However; the role of capital controls is found to be important:
 while these make exits less likely, once a country exits, they
 increase the likelihood that this will be orderly, a conclusion
 which contradicts the common wisdom.
CONCLUSION

 The most disruptive exits have occurred during
 the post liberalization period. The challenges
 confronting developing countries with fixed
 regimes are obvious.
REFERENCES:
 Asıcı, Ahmet Atıl, Nadezhda Ivanova and Charles Wyplosz (2007) “How to Exit from Fixed Exchange Rate
 Regimes”, forthcoming in International Journal of Finance and Economics

 “Understanding the Falling Dollar” Council on Foreign Relations, Monday, November 12, 2007;
 http://www.washingtonpost.com/wp-
 dyn/content/article/2007/11/12/AR2007111201075_Comments.html

 “How the falling dollar affects Americans”. By Ron Scherer;
 http://www.csmonitor.com/2007/0920/p01s02-usec.html

 “Why the dollar is falling so fast”. By Steve Schifferes , http://news.bbc.co.uk/2/hi/business/4772049.stm

 “The Shrinking Value of the Dollar”. http://www.infoplease.com/ipa/A0001519.html

 “The Dollar's Falling! Does It Really Matter?”. By Theodore F. di Stefano, http://www.ecommercetimes.com/



                       Thank you for your time and attention

				
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