Friday, April 8, 2011

Dollar Depreciates overnight...get ready to pay more for "stuff"...

A nice article illustrating two AP Macro concepts.  The first is the interest rate effect on the value of currencies relative to each other.  The European Central Bank (ECB) raised a benchmark interest rate yesterday.  As interest rates increase, we know financial capital flows to the "more desirable FINANCIAL ASSETS.  In this case European financial assets.  Hence, the demand for the Euro increased in the last 24 hours and the Euro has appreciated relative to the Dollar. 

In the short run (there seems to be debate about the long run) there is an inverse relationship between the value of the dollar in the FOREX and various commodities (metals, agricultural, oil, etc).  This is because most/all major commodities are traded on world markets in dollars. When the dollar depreciates then foreign sellers of commodities need to get more dollars (relative to before the depreciation) for their product just to maintain the same purchasing power of their own currency back in the home country.  This is the blessing and the curse of having the dollar as the currency of record for international trade.

Commodities rally as dollar slumps
The dollar has hit a fresh 15-month low as traders move into euros following the European Central Bank’s rate rise on Thursday.

Investors are dumping the buck as the US Federal Reserve is seen lagging in the nascent tightening cycle, while worries about a government shutdown should Washington budget talks fail are also adding to pressure on the greenback.

Commodities are a big beneficiary of the dollar’s decline. Dollar-denominated commodities like a softer buck and it seems the market is also still fond of the greenback as an inverse proxy to broad risk appetite.

Silver is in focus after it hit $40 an ounce for the first time since 1980 as traders also ride the “bullion-as-inflation-hedge” bandwagon.

The same strategy has also driven gold to a fresh record of $1,471 an ounce, with investors pouring funds into precious-metal exchange-traded funds.


  1. "...the US Federal Reserve is seen lagging in the nascent tightening cycle..."

    Off-topic to your post... The phrase I quoted emerges from the universal assumption that the only way to fight inflation is to raise interest rates.

    Not only do people see no alternative; they do not even consider looking for one. To me this means they do not realize that our standard policy solutions are the source of our economic troubles: Unchanging policy in a changing world.

    Off-topic? Told ya.

  2. Thanks, Art. As I was posting this I thought of you--you are getting inside my head. As a visitor to your blog everyday, I am seeing your way of thinking. It is unfortunate that at this point, people believe the emperor STILL has on clothes. EVERYDAY I ponder the numbers "35 to 1" and wonder how it escapes the attention of the mainstream.

  3. As we talked about in class, the depreciation of the dollar has the effect of increasing U.S. imports because foreign nations find it cheaper to buy U.S. good because their dollar has appreciated relative to the United States. So, with a depreciating dollar, the U.S. should be exporting more. However, does the increase in revenues made from exports balance out with the revenue lost from more expensive foreign goods?


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