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Currency Movements Punish Deficit Countries

Jun 10, 2008
Currency movements are an accepted risk when making international payments and can have a real and significant impact on profitability and cash flow for businesses involved in international trade. Over time movements in a nations currency will largely reflect how well or how poorly a nation is managing its international trading accounts.

A nation that is importing considerably more than it is exporting will tend to have a weak currency. One needs to look no further than the current trend of the US Dollar to see how this principal works in the real world.

Currency (foreign exchange) risks for companies involved in international trade necessitate pro active management, which in turn requires a certain level of expertise in currencies. Currency movements are not correlated to investments such as equities and bonds. Investment portfolios are thus valuable diversified by the addition of a foreign exchange component. Currency movements are momentum based. Rather than responding to standard fundamentals, a currency's value is in itself one of the most important fundamentals.

Foreign currency ETFs are bought and sold just like regular ETFs, throughout the day. Foreign exchange (forex) markets form the core of the global financial market, a seamless twenty-four hour structure dominated by sophisticated professional players such as commercial banks, central banks, hedge funds and forex brokers. Forex markets are often extremely volatile. Many investors, particularly American ones, tend to ignore currency movements, and few financial analysts are trained to analyze the details of forex markets.

Countries are trading more goods and services, an increasing number of firms now operate across national borders, and savers and borrowers have greater access than ever before to global financial markets. Over the past decade, world trade has grown twice as fast as world output, foreign direct investment three times as fast, and both currency trading and share trading about ten times as fast. This means that huge amounts of currencies are now being traded every business day. Up to three trillion dollars a day is the current estimate.

This heavy volume of trading means that no one entity, central banks included, can control the currency market. The currency market will severly punish those nations that manage their financial affairs poorly and it is beyond the power of the central bankers to reverse long term trends without a real change in policy. Jaw boning will not carry them very far. Generally, under such conditions countries that are heavy users of energy and have to import a large percentage of their energy needs would experience problems in maintaining a stable currency. Market forces will overpower the limited power of the central bank and take their currency lower.

Exchange rate movements favor surplus energy producing countries, like Russia and Canada, over energy deficit countries like the United States and Great Britain. You can expect a rise in the currency of the energy producing country and a decline in the currency of the energy importing country. This is a long term negative influence on the value of the US Dollar as the US is now paying through the nose for it's oil imports.

Fundamental analysis yields very little benefit when a market is in such a state. By definition, all that can be known is known, and is already reflected in prices. Fundamental analysis is based on the belief that there are cause-and-effect relationships that need to be understood in order for pricing anomalies to be sensibly identified and acted upon. Technical analysis is based on the assumption that past price relationships are indicative of future price relationships. Fundamental analysis is concerned with the reasons or causes for currency movements. Many Forex traders who rely on fundamental analysis plan their trading strategies around a number of key U.S. economic indicators.

Fundamentally, the United States lacks the industrial base to correct its trade imbalance. According to the Bureau of Census, roughly 25,000 manufacturing plants have been closed for good since 1998. In recent years, because of weak market conditions, manufacturing companies have cut back on plant and equipment spending. This is not healthy for the growth of the US economy.

In addition, the hollowing out of the US manufacturing sector this does not bode well for the strength of the US Dollar no matter how many rabbits Fed Chairman Ben Bernanke tries to pull out of his magic hat.
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