Archives for September 2010

Currency Intervention and its Impact

Recently, Japan intervened in the currency market for the first time in six years. Bank of Japan, the Japanese central bank, sold around yen 2 trillion in the currency market to stem an increase in the currency. The logic behind this is simple. A weaker yen will make Japanese exports more competitive, a very important thing for an economy like Japan, which relies on an export-led growth. However, what is the impact of currency intervention on an economy? Does currency intervention lead to global imbalances? In this article, we will look at the impact currency intervention can have.

Firstly, currency intervention is a zero-sum game. The gain made by the country that intervenes in the currency market comes at the expense of another country. Here is why. If Japan intervenes in the currency market by selling yen and buying dollar against it, the yen will become cheaper against the dollar, making Japanese exports to the U.S. cheaper. However, this will also make U.S. exports to Japan more expensive because the dollar has gained against the Japanese yen, resulting in lower exports from U.S. to Japan. Therefore the gains made by the Japanese exporters will come at the expense of U.S. exporters. This could in turn cause current account imbalances.

One major impact of currency intervention is increase in money supply. Therefore if an intervention is not followed by the mopping of excess liquidity, it could stoke inflation. In Japan’s case though, this may not be such a bad thing. However, in general, central banks mop up excess liquidity by issuing bonds to prevent stoking inflation.

Although currency intervention can be beneficial to the intervening country, it comes at a price. Firstly, it can lead to current account imbalances, a situation partly responsible for the recent financial crisis and secondly, the chances of stoking an inflation.

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German Business Confidence Rises for the month of September

German business confidence showed an unexpected increase for the month of September. The German business confidence increased to its highest level in over three years, indicating that companies in euro zone’s largest economy expect to remain robust even as the global economic recovery slows down.

According to the Munich-based Ifo Institute, the German business climate index rose to 106.8 in September from 106.7 in August. The index is based on a survey of 7,000 executives. The German economy has been robust even as the euro zone as a whole struggles to recover. The German economy grew at is fastest level since reunification in the second quarter of 2010.

However, going forward, things may become a little tougher for the German economy as the global economy slows down. The German economy relies very heavily on exports. Therefore any slowdown in the global economy will have an impact on Germany’s economy.

One bright spot for the German economy, however, has been the increasing consumer spending. Even as the global economy slows down, resulting in a drop in exports, demand from German consumers should enable the economy to maintain a steady growth rate. Consumer confidence reached an 11-month high in the month of September after unemployment declined for a 14th month in August.

This is in contrast with U.S. economy, which has been seeing high unemployment and low consumer confidence. Also, Germany has been able to grow at a time when other euro zone economies such as Ireland, Portugal, Spain and Greece struggle to overcome massive fiscal deficits. However, Germany will like to see a quicker recovery in the euro zone. This is because a major portion of German exports are in the euro zone itself. In the meantime, the strong consumer spending pattern should allow the German economy to grow at a steady pace.

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Pressure Increases on China to Raise the Value of Yuan

Since the beginning this year, China has been facing intense pressure from the U.S. to raise the value of the Yuan and to adopt a flexible exchange policy. The U.S. has been pressing China as it believes that an undervalued Yuan gives Chinese exporters an unfair advantage. In fact, the U.S. has even blamed the artificially weak Yuan as one of the reasons for global imbalances.

Earlier this year, some Republican senators wanted the U.S. to dub China as a “currency manipulator.” However, the U.S. government restrained from making such a strong statement.

China on its part has maintained that it will not raise the value of the Yuan and that the problems faced by the U.S. are largely homegrown. This week, Chinese premier, Wen Jiabao, said that if China raised the Yuan it could be catastrophic for the Chinese economy. However, as the pressure mounts, it is likely that China may allow a small appreciation in the Yuan.

Meanwhile in the U.S., a legislation forcing China to appreciate the Yuan is set for a vote in the House next week. Steny Hoyer, a Democratic leader of Maryland, said that U.S. cannot wait any longer to level the playing field for its businesses and protect American manufacturing jobs.

In the first seven months of 2010, the U.S. trade deficit with China widened to $145 billion. Since June 19, the Chinese currency has appreciated 2% against the U.S. dollar. However, both Republicans and Democrats believe that this is not enough and that China needs to do more.

Earlier this week, U.S. President Barrack Obama met with the Chinese premier at the United Nations. With the pressure increasing on China, the relation between the two countries, which has always been fragile, is likely to be tested.

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Latest Economic Data Suggests that U.S. Economic Recovery is on Track

The U.S. Commerce Department, Friday, reported some positive economic data. The Commerce Department reported that U.S. wholesale inventories increased by 1.3% for the month of July. This was biggest rise for any month since July 2008. The data came in ahead of analysts’ expectations.

Following the stronger-than-expected results, some analysts raised their growth forecast for the third quarter of 2010. It may be recalled that the U.S. economy grew by an impressive 5.7% in the first quarter of 2010. However, growth in the second quarter slowed down, which led to concerns of a double-dip recession. The latest wholesale inventory data should give markets some confidence about the U.S. economy.

Apart from the better-than-expected wholesale inventory data, last week, there was some more positive news on the economic front. For the month of August, private sector job growth also came in ahead of expectations.

Also, economists anticipate an increase in retail sales in the U.S. for the month of August. According to a survey of economist conducted by Bloomberg News, the U.S. retail sales increased by 0.3% for the month of August. Retail sales had increased by 0.4% in the month of July. The Commerce Department will release the retail sales data on Tuesday.

According to a survey conducted by Bloomberg, the Thomson Reuters/ University of Michigan’s preliminary index of consumer sentiment data increased to 70 in the month of September. The actual data will be released on September 17.

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