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Joe Barbieri has Bachelors' degrees in both Civil Engineering and Commerce from the University of Toronto. He has worked in the Financial Services field for over 13 years, with over 10 years on the institutional side of the business. He has covered positions from Fund Accounting to Investment... More
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  • Is The Influence Of Central Banks Skewed Toward Currency Weakness? 0 comments
    Nov 15, 2013 4:10 PM

    banks have large influence over markets in general. They have been a large factor in the manipulation of currencies through interest rate policy and the issuance of new money. The theory states that if a country devalues its currency, its goods will be cheaper and will make its exports rise and imports fall. This would in turn lead to more employment in that country and create prosperity. The consequences of this action are not discussed and are typically not known. So if one country begins to devalue its currency and it produces prosperity, wouldn't other countries try the same thing? In fact, this is what has been happening for years already. The theory does not account for the fact that a currency is cheap only relative to other currencies. If everyone does the same thing, the effects are mitigated. (1) It has become a situation where if your currency is not weakened, there is a risk of going into recession. To add more pressure to the situation, high deficits and debt loads combined with a recession would make sustaining the country finances unsustainable. Rising interest rates would become devastating even to a slight degree.

    Central banks now are resorting to getting a market effect through surprise announcements. This tactic is not new, but it is differing from the past in that surprises are tending toward currency weakness through issuing more monetary units. In the past, such surprises could have gone in a tightening or loosening direction with respect to policy announcements. In the last few years, most of these announcements have been surprise rate cut drops, or "quantitative easing" type announcements. (2) Are central banks boxing themselves into a corner with the "easy money policy" and are now resorting to surprise tactics to make their policy effective? If they want to change course, is it still possible?

    What to do with this information? As with most things that are uncertain, be aware of where the uncertainty comes from. Have a backup plan or hedge in case of surprises and diversify against the unexpected. If the bias is toward a weakening currency, this could be a hint as to where the surprises will tend to arise. If there is talk of a reversal in strategy or tightening like the Fed taper experiment, ask yourself how possible it really is to change course with respect to large debts, economic growth and disruption to the status quo.

    Sources:

    1) http://www.bloomberg.com/news/2013-11-11/race-to-bottom-resumes-as-central-bankers-ease-anew-currencies.html

    2) http://www.reuters.com/article/2013/11/10/us-economy-global-weekahead-idUSBRE9A90EA20131110

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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