Will The Dollar Crash? Part 2
February 15th, 2006 | by Digvijay Lamba |I wrote a post earlier about how the international currency market works. I am going to add some concrete links and data to the points I made earlier in this post. This is strictly for the readers who want to go into more depth as it basically supports and gives sources for the points I mentioned earlier.
Firstly, the entire concept where I compared the currency markets to the stock markets has a good explanation here: Foreign exchange market – Wikipedia. As they correctly mention, there is no central market or location where this trading takes place. Rather it is a widespread exchange of currencies, including private, government and bank transactions that make up this huge market.
The controlling body which regulates this market is an association of the Central and Reserve banks of the various countries called the Bank for International Settlements – Wikipedia. This is the overall regulating body.
How the regulation takes place is a topic for another time. A starting point for such a study would be to understand the various Exchange Rate Regime’s the governments follow. You can start at Exchange rate regime – Wikipedia. In brief, the three main regimes are Floating Rate (Where exchange is determined by the market and controlled by regulators), Fixed Rate (Where the exchange rate is fixed with another currency), and the in between Pegged Float (Exchange rate is fixed in a band or periodically adjusted from outside the market).
Another topic that I spoke about in that article is the use of Gold as a currency. Now the Gold Standard was used for a long time in international affairs and most currencies were given valuations against a standard weight of gold, and gold was used the determinant of exchange rate. The growth of Dollar’s use for the same purpose led to the end of the Gold Standard. You can read about this and details of various major impacts on International Finance that Gold Standard has had at Gold standard – Wikipedia.
However, most international reserve banks continue to maintain large reserves of gold to hedge against there dependence on Dollar. In fact, 25% of the worlds gold is held in Reserve banks. You can see detailed statistics on the link I gave earlier, but to summarize when Dollar falls the prices of gold rise as the countries start buying gold to hedge against the increased Dollar supply.
The article I wrote takes a neutral approach and does not take a definite stand. I plan to present the two sides again here and leave the determination of my stand to the reader.
First, A typical naysayer, doomsday stand is taken in the article at Towards Liberty: Death of the Dollar. The main points that these people talk about are essentially related to Historical similarities, and (in my opinion) exaggerated claims about the overvaluation of the dollar. The article I just pointed to takes a strict stand but makes some definitely strong points to support it.
The next article I present gives a well thought out view against such a crash. Paul Duncombe: Will the Dollar Crash? talks about the danger and how it is really a cyclic issue and is being handled by the various parties involved. It is the best impartial analysis I could find.
The final point I touched in my post considered the question of the Chinese currency. A good analysis of this issue can be found at Prospects for China’s Currency Revaluation – Center for American Progress. The article says, and I agree, that the near term possibility of an increase in Chinese currencies price is not likely. The prime reason this was thought to be a good option for China was to control an economy growing far too rapidly, so much so that inflation and interest rates were getting difficult to control. The slight slowdown in China’s growth this year, doubled with lowering of Oil prices has caused these factors to diminish. While in the long term it’s a likely possibility that China will indeed re-valuate the Yuan, it’s likely to happen in a slow and phased manner. China’s main concern is to protects its troubled banking industry and a sudden re-valuation can put pressure on the currency that the banks may not be able to handle.
Finally, as to whether the change in value of Yuan willl really solve Dollar’s problems, the following article is a good summary. FOXNews.com – Views News – CATO – Chinese Currency Issue is a Red Herring. In brief, it says that while the Chinese currency is definitely a factor it is not a large enough cause for the US trade deficit and Dollar’s problems to be a solution in and of itself. Rather it’s merely one of the many steps that government must take.
To conclude, I believe all the movements in currency prices will happen in the direction everyone expects. It’s just not likely to happen suddenly and cause a worldwide economic meltdown. Rather, a slowly emerging Euro will balance out the Dollar a little and will become an alternate currency as Europe becomes a bigger player.
Technorati Tags: Dollar, Yuan, Currency Exchange, Fiscal Policy, Currency Markets
Tags: Dollar Crash, Economics, Issues
One Response to “Will The Dollar Crash? Part 2”
By Naveen on Feb 17, 2006 | Reply
Hi,
Interesting article..surely have put in quite an effort to write this..
Naveen