July 6th, 2008, 14:47
I've been waiting for WhiteDesire, the Forum's hot-shot forex trader, to let us know about the following article from this week's Economist but I fear it contains too many long words for him.
The full article link - http://www.economist.com/finance/displa ... d=11667810 (http://www.economist.com/finance/displaystory.cfm?story_id=11667810) :
Many currencies that are backed by a current-account deficit are now falling just as the dollar has
http://media.economist.com/images/20080705/CFN543.gif
ACCORDING to economic textbooks, the currencies of economies with large current-account deficits should depreciate relative to those of countries with surpluses. This will stimulate their exports and curb imports, thereby helping to slim the trade gaps. America has the worldтАЩs biggest current-account deficit and the dollar has dutifully been falling since 2002. Oddly, however, the currencies of many other countries with large deficits had enjoyed big gains until recently. Now, at last, currency markets have started to see sense.
Britain, Australia, New Zealand and Iceland all have large current-account deficits (along with many other American-style excesses, such as housing and credit booms). Yet over several years until mid-2007, their currencies perversely rose relative to those of economies, such as Japan and Switzerland, with big surpluses. For example, despite a current-account surplus of 4.9% of GDP last year, one of the biggest of any developed economy, JapanтАЩs trade-weighted exchange rate sank by 13% from the end of 2002 to mid-2007. New Zealand, where the deficit reached 8% of GDP (bigger than AmericaтАЩs deficit of 6% of GDP at its peak), saw its currency gain 28% over the same period.
This paradox is the result of the тАЬcarry tradeтАЭ, a popular currency strategy that partly explains why trade flows are now dwarfed by cross-border capital flows. In a world of low interest rates, international investors were hungry for yield, and so piled into currencies that offered higher interest rates, namely those of Britain, Australia, New Zealand and Iceland, as well as many emerging markets. Those higher interest rates paid by countries with large external deficits were supposed to compensate investors for the risk of currency depreciation. But as investors borrowed in low-interest currencies, such as the yen, to invest in high-yielding ones, this made the latter currencies stronger. That, in turn, prolonged global imbalances by making it easier for profligate countries to finance their current-account deficits.
But since the eruption of global financial turmoil last year and the dwindling appetite for risk, carry trades have started to unwind and it has become harder to finance deficits. As a result, current-account imbalances are once again exerting a powerful influence over currencies. The chart shows that the weakest currencies this year have been in countries with deficits, from Britain to South Africa. In contrast, the yen and the Swiss franc have perked up. The same chart a year or so ago would have shown virtually the opposite relationship.
The full article link - http://www.economist.com/finance/displa ... d=11667810 (http://www.economist.com/finance/displaystory.cfm?story_id=11667810) :
Many currencies that are backed by a current-account deficit are now falling just as the dollar has
http://media.economist.com/images/20080705/CFN543.gif
ACCORDING to economic textbooks, the currencies of economies with large current-account deficits should depreciate relative to those of countries with surpluses. This will stimulate their exports and curb imports, thereby helping to slim the trade gaps. America has the worldтАЩs biggest current-account deficit and the dollar has dutifully been falling since 2002. Oddly, however, the currencies of many other countries with large deficits had enjoyed big gains until recently. Now, at last, currency markets have started to see sense.
Britain, Australia, New Zealand and Iceland all have large current-account deficits (along with many other American-style excesses, such as housing and credit booms). Yet over several years until mid-2007, their currencies perversely rose relative to those of economies, such as Japan and Switzerland, with big surpluses. For example, despite a current-account surplus of 4.9% of GDP last year, one of the biggest of any developed economy, JapanтАЩs trade-weighted exchange rate sank by 13% from the end of 2002 to mid-2007. New Zealand, where the deficit reached 8% of GDP (bigger than AmericaтАЩs deficit of 6% of GDP at its peak), saw its currency gain 28% over the same period.
This paradox is the result of the тАЬcarry tradeтАЭ, a popular currency strategy that partly explains why trade flows are now dwarfed by cross-border capital flows. In a world of low interest rates, international investors were hungry for yield, and so piled into currencies that offered higher interest rates, namely those of Britain, Australia, New Zealand and Iceland, as well as many emerging markets. Those higher interest rates paid by countries with large external deficits were supposed to compensate investors for the risk of currency depreciation. But as investors borrowed in low-interest currencies, such as the yen, to invest in high-yielding ones, this made the latter currencies stronger. That, in turn, prolonged global imbalances by making it easier for profligate countries to finance their current-account deficits.
But since the eruption of global financial turmoil last year and the dwindling appetite for risk, carry trades have started to unwind and it has become harder to finance deficits. As a result, current-account imbalances are once again exerting a powerful influence over currencies. The chart shows that the weakest currencies this year have been in countries with deficits, from Britain to South Africa. In contrast, the yen and the Swiss franc have perked up. The same chart a year or so ago would have shown virtually the opposite relationship.