Wednesday, October 29, 2008

Why The Dollar Strengthened Despite Economic Woes?

(1) Calling for loans. As credit begins to dry up, US banks started to call in loans lent out to brokerage, securities firms and banks outside the greenback. Call loans are loans that are repayable immediately upon call & its interest rates are calculated on daily basis. Therefore to repay those banks, the borrowers will have to supply home currency & demand for dollar. This explains why dollar gains strength

(2) Growing unattractiveness of UK & Eurozone. UK economy is now in a mess. Unemployment had risen to a level we have not seen for years. More firms are cutting output. Meanwhile its economy will inevitably fall into recession for the first time in 16 years given the 3rd quarter’s GDP had contracted by 0.5%. To refresh your memory, recession is defined as 2 successive quarters of negative economic growth.

Eurozone economy doesn’t fare that well either. Its economy is much exposed to the threat of collapsed in Eastern European economies such as Hungary, Ukraine, Belarus, Russia etc. This is accrued to 2 reasons. First, European banks especially Germany & Austria had lent heavily to financially ill countries like Ukraine & Hungary which had turned to IMF recently. Second, Western & Eastern Europe have strong tie via trade. It seems that their economy will really slow down for some time. Therefore investors flee pound & euro denominated assets & demand for dollar

(3) Issuance of debts. Interestingly, the yen has appreciated against dollar. But this will not be long. US will soon issue debts to finance its budget deficit & bank bailouts. Many countries especially Japan will buy more of those debts to artificially keep yen lower than dollar, so that Japan can export itself out of depression. China is also likely to buy those debts, possibly causing the Chinese renminbi to be further lowered against dollar

(4) Possible lower interest rates. Many cash rich businessman & institutional investors from States begin to withdraw monies from UK & European banks due to the anticipation of further cut in interest rates to boost economic growth. This is a sign that savings in these banks are less attractive now due to lower yielding rate. At the moment of writing, interest rates is 4.5% in UK & 3.75% in Euro (which means much space for further cut)

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