“There is only one route for the euro, towards 1.08 in the US dollars by the end of this year and towards the eventual parity in 2011”, forecast an expert in a TV interview during the heydays of the euro crisis in the beginning of June 2010. The actual exchange rate was then 1.20 US dollars per euro.
Only two years before, in May 2008, when the euro hovered at 1.55, another currency strategist forecast: “there is only one route for the US dollar, towards 1.70 by the year end”. Incidentally, the euro touched 1.25 half a year later – and 1.50 in subsequent November in 2009.
Forex-strategists may in passing mention purchasing power parity (PPP), but most often emphasize short-term trends that may not at all be based on a convergence towards PPP but on recognition by technical analysts, that is, by those who try to find out recurring patterns in the historical data. PPP is a theory of the intrinsic value of a currency: the equilibrium exchange rate equates the cost of an average goods basket in the two currency areas. When PPP holds true, a dollar or a euro buys the same basket irrespective of the country where it is expended.
The best available estimate for the correct long-term value of the euro in the US dollars is based on the average goods basket of the OECD countries as calculated by the Ifo Institute in Munich, Germany, the most recent value of 1.17 being published in CESifo Forum 3/2010, p. 39. Were the US basket the reference the parity of the two currencies would roughly represent the PPP indeed. And in respect of the German basket, the PPP value is not far from the current exchange rate of 1.40.
The euro zone contains countries with a lower level of general prices than in Germany. Hence the rise of the euro to 1.55 in 2008 may not have represented any drastic overvaluation in terms of the euro-zone basket of goods. In fact, during the Carter administration the US dollar was much weaker, about 1.70 dollars per euro.
The preferred OECD purchasing power parity of 1.17 in contrast to the current exchange rate of 1.40 implies about a 10 per cent overvaluation of the euro. But, how quickly does the exchange rate of a currency converge to its PPP value?
The established robust econometric result during my life-time of teaching was that any discrepancy from the PPP would be halved over the medium term which most researchers interpreted as anything from one and half years to three years. From this perspective the forecast for the dollar exchange rate of the euro for November 2011 is that the euro would slightly depreciate against the US dollar. – And experience shows that we will experience much wider fluctuations.
This leaves ample room for the real actors in the currency (forex) markets: find a trend, trade the trend, and ride the trend. For a forex trader a trend in an exchange rate is like bureaucracy: it does not pay to fight against it.
Showing posts with label euro. Show all posts
Showing posts with label euro. Show all posts
Sunday, November 7, 2010
Tuesday, January 20, 2009
Preventing the world from central bankers’ ego
Instead of Keynes, would the old Friedman rule be worth studying again? Milton Friedman invented his rigid rule for monetary growth to save the citizens of a free society from the central bankers’ ego unlike Lenin’s instruction to most effectively destroy a society by destroying its money.
Friedman was fearful of “the assignment of wide discretionary powers to a group of technicians, gathered together in an ‘independent’ central bank” and wanted “to establish institutional arrangements that will enable government to exercise responsibility for money, yet at the same time limit the power thereby given to government and prevent this power from being used in ways that will tend to weaken rather than strengthen a free society”; Capitalism and Freedom (1962, p. 39). Friedman introduced the idea of a constant annual rate of growth of money stock, regardless of changing economic conditions, to curtail the discretionary power of the monetary authorities in A Program for Monetary Stability (1959).
“The fact is that the Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than any inherent instability of the private economy”; the Federal Reserve System exercised its power to conduct monetary policy “so ineptly as to convert what otherwise would have been a moderate contraction into a major catastrophe” (C&F, p. 38).
By Friedman’s hindsight, the error list of the Fed included the unusually tight monetary conditions since mid-1928 culminating in an attempt to curb “speculation”, but leading to the 1929 stock market crash - that is, the Fed pricked the bubble which Greenspan’s Fed declined to carry out; the money stock declined by nearly 3 per cent from August 1929 to October 1930 – “a larger decline than during the whole of all but the most severe prior contractions”; prior to October 1930, there had been no sign of a liquidity crisis, or any loss of confidence in banks, but thereafter the economy was plagued by recurrent liquidity crises, runs on banks and waves of bank failures, but the Fed “stood idly by” because of “will, not of power”; Britain went off the gold standard in September 1931 inducing gold withdrawals from the USA, but two years of severe economic contraction did not prevent the Fed from defending the dollar and ending the gold drain by raising the discount rate – the rate at which it lent to member banks; the US money stock fell by one third from July 1929 to March 1933 with over two-thirds of the decline after Britain’s departure from the gold standard.
No wonder, Friedman wanted to avoid important policy actions being “highly dependent on accidents of personality” by introducing his rule of money growth that would also prevent monetary policy from being subject to the day-to-day whim of the politicians.
Was Alan Greenspan’s ego too big because of Friedman’s infamous research on and critique of the US monetary policy of the 1930s in A Monetary History of the United States 1967-1960 with Anna Swartz (1963)? Did Alan want to show how the Fed’s errors of the 1930s can be avoided? Alan fought preventively against “deflation”, a continuous downward spiral of prices and wages, in 2003-2005 during the most rapid global economic growth ever experienced! Greenspan’s Fed ridiculed active monetary policy by inventing to raise the steering rate of interest at a “measured” pace – the flip side of Friedman’s rule of a constant rate of growth of money supply?
What went wrong? The world is a global village was already taught in the mid-1960s. With a number of emerging market currencies pegged to the US dollar and the pound sterling and the euro shadowing the US policy rate changes, the USA is no longer a small open economy. The Fed ought to have a surveillance of monetary and fiscal conditions in the whole dollar block, not only the US economy, before taking decisions.
Also, the new rule of raising the steering rate at a “measured” pace softened the signal of monetary policy to the market participants in contrast to the previous policy actions and greatly increased long-term uncertainty about inflation and interest rates though making the next policy step more predictable - and lulled all financial journalists as well.
Is Ben Bernanke’s ego also too big? He earned his academic credentials by research on the Great Depression, lectured as a Governor of the Fed on quantitative easing, Deflation: Making Sure "It" Doesn't Happen Here, by using the balance sheet of the Fed. He is regarded as THE expert on financial crises, on exactly those sequences of events the world has experienced during the past two years.
This crisis has shown that Keynes's green cheese, money created by the banks and other financial intermediaries, is no substitute for the US treasuries in case of real excess demand for the “moon”, currency and highly liquid government bonds. So, global imbalances and their financing patterns matter for monetary policy.
Friedman confessed in the 1986 Economic Inquiry that his “rule” did not satisfy the most basic incentive scheme because it was not in the self-interest of the Fed hierarchy to follow the hypothetical policy of such a rule. But in the end, Friedman was after getting rid of the whole Fed: private markets would deliver financial and price stability at equal or less resource cost.
Friedman was fearful of “the assignment of wide discretionary powers to a group of technicians, gathered together in an ‘independent’ central bank” and wanted “to establish institutional arrangements that will enable government to exercise responsibility for money, yet at the same time limit the power thereby given to government and prevent this power from being used in ways that will tend to weaken rather than strengthen a free society”; Capitalism and Freedom (1962, p. 39). Friedman introduced the idea of a constant annual rate of growth of money stock, regardless of changing economic conditions, to curtail the discretionary power of the monetary authorities in A Program for Monetary Stability (1959).
“The fact is that the Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than any inherent instability of the private economy”; the Federal Reserve System exercised its power to conduct monetary policy “so ineptly as to convert what otherwise would have been a moderate contraction into a major catastrophe” (C&F, p. 38).
By Friedman’s hindsight, the error list of the Fed included the unusually tight monetary conditions since mid-1928 culminating in an attempt to curb “speculation”, but leading to the 1929 stock market crash - that is, the Fed pricked the bubble which Greenspan’s Fed declined to carry out; the money stock declined by nearly 3 per cent from August 1929 to October 1930 – “a larger decline than during the whole of all but the most severe prior contractions”; prior to October 1930, there had been no sign of a liquidity crisis, or any loss of confidence in banks, but thereafter the economy was plagued by recurrent liquidity crises, runs on banks and waves of bank failures, but the Fed “stood idly by” because of “will, not of power”; Britain went off the gold standard in September 1931 inducing gold withdrawals from the USA, but two years of severe economic contraction did not prevent the Fed from defending the dollar and ending the gold drain by raising the discount rate – the rate at which it lent to member banks; the US money stock fell by one third from July 1929 to March 1933 with over two-thirds of the decline after Britain’s departure from the gold standard.
No wonder, Friedman wanted to avoid important policy actions being “highly dependent on accidents of personality” by introducing his rule of money growth that would also prevent monetary policy from being subject to the day-to-day whim of the politicians.
Was Alan Greenspan’s ego too big because of Friedman’s infamous research on and critique of the US monetary policy of the 1930s in A Monetary History of the United States 1967-1960 with Anna Swartz (1963)? Did Alan want to show how the Fed’s errors of the 1930s can be avoided? Alan fought preventively against “deflation”, a continuous downward spiral of prices and wages, in 2003-2005 during the most rapid global economic growth ever experienced! Greenspan’s Fed ridiculed active monetary policy by inventing to raise the steering rate of interest at a “measured” pace – the flip side of Friedman’s rule of a constant rate of growth of money supply?
What went wrong? The world is a global village was already taught in the mid-1960s. With a number of emerging market currencies pegged to the US dollar and the pound sterling and the euro shadowing the US policy rate changes, the USA is no longer a small open economy. The Fed ought to have a surveillance of monetary and fiscal conditions in the whole dollar block, not only the US economy, before taking decisions.
Also, the new rule of raising the steering rate at a “measured” pace softened the signal of monetary policy to the market participants in contrast to the previous policy actions and greatly increased long-term uncertainty about inflation and interest rates though making the next policy step more predictable - and lulled all financial journalists as well.
Is Ben Bernanke’s ego also too big? He earned his academic credentials by research on the Great Depression, lectured as a Governor of the Fed on quantitative easing, Deflation: Making Sure "It" Doesn't Happen Here, by using the balance sheet of the Fed. He is regarded as THE expert on financial crises, on exactly those sequences of events the world has experienced during the past two years.
This crisis has shown that Keynes's green cheese, money created by the banks and other financial intermediaries, is no substitute for the US treasuries in case of real excess demand for the “moon”, currency and highly liquid government bonds. So, global imbalances and their financing patterns matter for monetary policy.
Friedman confessed in the 1986 Economic Inquiry that his “rule” did not satisfy the most basic incentive scheme because it was not in the self-interest of the Fed hierarchy to follow the hypothetical policy of such a rule. But in the end, Friedman was after getting rid of the whole Fed: private markets would deliver financial and price stability at equal or less resource cost.
Friday, April 11, 2008
The ECB dozed off!
In Britain the target rate of inflation is set by the Chancellor of the Exchequer (Minister of Finance). Whenever the actual inflation rate surpasses the target by more than one percentage point the Governor of the Bank of England, on behalf of its Monetary Policy Committee (MPC), must send the Chancellor an open letter, explaining
1. the reasons why inflation has risen above the target,
2. policy action that the MPC proposes to deal with it,
3. the period within which the MPC expects inflation to return to the target, and
4. how the approach chosen by the MPC meets the UK Government’s monetary policy objectives.
These points appear in the introduction of the Governor’s letter of 17 April 2007 to the Chancellor.
The actual inflation in the Euro area exceeded its target – to keep inflation below 2 percent - by more than one percentage point last November. The introductory statement by Jean-Claude Trichet, President of the ECB, before yesterday’s press conference gave many reasons why the Euro area inflation has risen above the target and will stay above it for “a rather protracted period” which Mr. Trichet spelled out to 18 months in his answer to a journalist’s question.
But, all those reasons are outside reasons, as if they were beyond the control of the Governing Council of the ECB. They are not. There is no explicit mention that the inflation rate doubled in the Euro area since last August because of its lax monetary policy that shadowed the Fed’s decisions.
We not only read in the statement about “continuing very vigorous money and credit growth”, without implication in the doubling of the ECB’s favorite measure of inflation, but also “We (the Council) believe that the current monetary policy stance will contribute to achieving our objective” of maintaining price stability in the medium term.
Only a belief is offered to us, but nothing in explanation of policy conduct; as Pandora’s box, all evil spirits have escaped, only Hope remains!
The decision making bodies of the ECB will reach a middle-school girl’s age next June. It is time to publish the reasoning and argumentation behind the decisions of the Governing Council, the minutes of its meetings. Also, greater transparency necessitates a similar institutional arrangement as the Governor’s letter to the Chancellor in Britain.
Two years ago the ECB was “vigilant”, sometimes even “extremely vigilant”, no longer. Yesterday Mr. Trichet mentioned twice that the Council is “alert”.
Transparency does require mentioning when the Governing Council dozes off!
1. the reasons why inflation has risen above the target,
2. policy action that the MPC proposes to deal with it,
3. the period within which the MPC expects inflation to return to the target, and
4. how the approach chosen by the MPC meets the UK Government’s monetary policy objectives.
These points appear in the introduction of the Governor’s letter of 17 April 2007 to the Chancellor.
The actual inflation in the Euro area exceeded its target – to keep inflation below 2 percent - by more than one percentage point last November. The introductory statement by Jean-Claude Trichet, President of the ECB, before yesterday’s press conference gave many reasons why the Euro area inflation has risen above the target and will stay above it for “a rather protracted period” which Mr. Trichet spelled out to 18 months in his answer to a journalist’s question.
But, all those reasons are outside reasons, as if they were beyond the control of the Governing Council of the ECB. They are not. There is no explicit mention that the inflation rate doubled in the Euro area since last August because of its lax monetary policy that shadowed the Fed’s decisions.
We not only read in the statement about “continuing very vigorous money and credit growth”, without implication in the doubling of the ECB’s favorite measure of inflation, but also “We (the Council) believe that the current monetary policy stance will contribute to achieving our objective” of maintaining price stability in the medium term.
Only a belief is offered to us, but nothing in explanation of policy conduct; as Pandora’s box, all evil spirits have escaped, only Hope remains!
The decision making bodies of the ECB will reach a middle-school girl’s age next June. It is time to publish the reasoning and argumentation behind the decisions of the Governing Council, the minutes of its meetings. Also, greater transparency necessitates a similar institutional arrangement as the Governor’s letter to the Chancellor in Britain.
Two years ago the ECB was “vigilant”, sometimes even “extremely vigilant”, no longer. Yesterday Mr. Trichet mentioned twice that the Council is “alert”.
Transparency does require mentioning when the Governing Council dozes off!
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