Taking A Look Into The US Dollar

The USD rise lately has given much discussion whether is it in the office space or with friends and family. Though I am not the currency guy with any experience, anyway I don't fancy currency trading due too its volatile nature it is nevertheless important to know the basic of it that builds our economy. I also need to know because I am holding some USD denominated assets.

Everyone knows the US dollar is the world's currency. This is due to the fact that is the most widely transacted money in the world and also is the world's reserve currency. It alone holds 60% of all reserves globally only to be competed next by Euro at ~27%. The US also boast great stability thanks to their almighty United States Treasury. There is currently no good substitute against the US dollar. Euro has problems due to the sovereign debt crisis they are having, Yen is too weak, after all they are still technically in recession for very very long time. Yuan is also a no having subject to capital controls and therefore not attractive in the world of free market.

The USD movement has a lot to do with the FEDs, a.k.a America's Federal Reserve System. The chairman is easily the world's second most powerful man (before the President) if not the most powerful man in the America. The Fed is a mix of public and private institutions whose sole main purpose is to do two main things: ensure low inflation rate & steady economic growth. The Fed is America's central bank just like our BNM. It is has extremely godly powers including lending to banks if they run out of money to pay its creditors. This is what happened during the 2008/09 financial crisis period. The other power is having the ability to carry out monetary policy meaning it can control the supply of money, or raising/lowering the interest rates to to hold down inflation or preventing deep recessions.

Many people are confused or can I say brainwashed by the fact that they control the entire economy. Wrong! As with all central banks worldwide, they CANNOT make the economy grow more quickly or produce jobs, this depends on other factors (which I will talk in a separate posting). The central banks have tremendous power over the business cycle ONLY. By controlling the interest rates, they can control household spending and the prices of goods.

The Feds in America meet 8 times a year and is the most widely monitored and followed event in the financial world. It is independent because the President and Congress has no control over their decisions except by appointing the Chairman. I am not overstating their power, they truly have lots of because it can control the USD's supply at will to protect financial systems from panics and secondarily to manage business cycle.

Usually the central will use the interest rate avoid recessions or hyperinflation but because the US has already fell the rates to near zero levels at 0.25% and it has not helped the economy a lot it has resorted to what they call Quantitative Easing a.k.a QE. In layman terms it is called printing more money and flooding the market with it to create more liquidity. It is essentially buying more more bonds that will push-down long term interest rates. By flooding the market with more of its US currency, it makes the currency less valuable and thus we see the USD going down since QE and QE2. All that will change if QE3 does not happen and the global economy continues its path of mediocre growth.

The question is will QE3 happen? I take a look at the US's debt ceiling limit which is set at ~USD14 trillion. BUT the catch is that this ceiling has been raised a total of 74 times. If the US blows the debt ceiling again meaning they can't borrow more money the govt has three choices: cut spending or increase taxes by September 30 which is the end of their fiscal year. The other way is to default some of their debt obligations and risk cutting their triple-A credit rating making the US dollar less favorable as the world's reserve currency. There's more ways to get away from debt (again I'll leave that topic for another posting).

In my opinion, it seems that the US has gotten itself into you can say a breaking point. I would see that they will come into a political compromise to cut government spending and also increase the tax for the wealthiest portions of the American society since they are already so damn rich. They could also however increase taxes to all Americans to curb consumption and increase savings, not likely because that defeats the purpose of them to encourage spending to promote economic growth. BUT because the US is still very much favorable to be the world's currency made part by their good long-term economic growth (highest population birth rate in the developed world, has capital and not short of innovation), I cannot rule out that they will raise the debt ceiling and thus QE3, printing more money. I would give it a 60/40 chance hoping they realized that you cannot get out of debt by having more debt anymore. There needs to be a point where you need to stop all these and go into reserve mode before they go into a really big SHIT of mess.

I have gotten USD-Ringgit levels right twice. I may not be lucky for the third time but let me try my best. It will hover at 3.00 with a range between 2.9 to 3.1. BNM will try to hold the USD at a competitive rate as we are still an export driven country, Malaysia. I set a range this time because there is a possibility of QE3 and it will drive the USD weaker to 2.9 which can help reduce their debt to a certain extend because the value goes down. Smart asses!

Reference: http://money.cnn.com/2011/05/16/news/economy/debt_ceiling_deadline/index.htm