Ultimately, they reflect the underlying strength or weakness of the real economy
AS the textbook says, money is a means of exchange, a unit of account and a store of value. When we discuss foreign exchange rates, we mean the value of the domestic currency against a foreign benchmark.
Since there are many such benchmarks or standards, we use the most common one, which is the US dollar. This is because the US dollar is the most widely used reserve currency, as it accounts for roughly two-thirds of global foreign exchange trading and official foreign exchange reserves.
Most people use the US dollar standard because not only is it the most convenient, it also by and large has been a good store of value, at least relative to other currencies.
If you travel as a tourist in most parts of the world, you will find that you cannot change your own currency easily, but you can easily change against the US dollar. The US dollar is the reserve currency standard because it meets all the conditions of international unit of account, means of payment and store of value.
But with the US running unsustainable current account deficits and a growing net foreign debt position, the US dollar faces structural depreciation, which creates growing uncertainty on a global scale.
The real problem stems from the fact that all foreign exchange rates are relative and not absolute values. Value is relative not only against real goods, but against other paper currencies.
If we use a metal as standard, such as gold, and the quantum of gold remains static as the global demand for liquidity increases, then prices will be deflationary. The gold standard was found to be too strict a disciplinarian, because if all currencies are linked to gold, you cannot run a fiscal or trade deficit without huge outflows of gold.
The advantage of using a paper currency is that the supply can be adjusted to the national or global needs. As monetarists claim, inflation is basically a monetary problem of printing too much money. Money can be printed through growing fiscal debt, growing bank credit or inflow of foreign funds.
You can print domestic money, but you can’t print foreign money. In other words, you can ask domestic people to bear the inflation tax by printing money, but the foreigner (and today locals) can run through capital outflow. They stop investing and lending money and you end up with a fiscal or currency crisis.
The bottom line is that in the long run, you cannot spend more than what you earn. Thus, when conventional economists say that flexible exchange rates help with monetary policy, they think that there is an easy way out of this problem.
Flexible exchange rates may help a little in day-to-day adjustment in prices, but ultimately, there is always the temptation to use the exchange rate to devalue your way out of the fundamental problem of spending more than you earn.
This is exactly the Greek tragedy. Greece is part of the eurozone, which uses the Maastricht Treaty rules to stop member countries from printing too much money to ensure that the euro will have stable value. The Maastricht rules draw the line of the annual fiscal deficit at not more than 3% of GDP (or gross domestic product) and total fiscal debt at 60% of GDP.
The Greeks ran a fiscal deficit of more than 12.7% deficit in 2009 and total fiscal debt is now at 120% of GDP. They hid the deficits for more than 10 years by various tricks, including using investment bankers to do swaps to hide the deficits.
In the 1990s, leading investment banks were fined in Japan for helping Japanese companies and banks hide their losses. Now they are bold enough to help governments hide their deficits.
To put it bluntly, neither fixed nor flexible exchange rates can hide the fact that if a borrower spends more than it earns, be it a company or a government, the day of reckoning will come soon.
Fixed exchange rates are a discipline – the profligacy will show up very fast. Flexible exchange rates use a weaker currency to try and earn more exports. But if the source of overspending is the government aided by loose monetary policy, then sooner or later the foreigner will stop lending or investing. You cannot jazz your way out of over-spending. Sooner or later the music must stop.
The Greeks thought that being part of the eurozone, the other Europeans would bail out Greece, so non-Greeks will help pay for their over-spending. Since Greece cannot devalue the euro by itself, then the pain of adjustment must be done on the fiscal or employment side. In other words, a fixed exchange rate ultimately forces the structural adjustment. The Europeans are asking Greece to make that adjustment as a condition for help.
We cannot think about exchange rates as only bilateral, that is, between currency A and currency B. We saw that before the Asian crisis, when East Asian currencies were mostly benchmarked against the US dollar, with some fixed and others floating. Nevertheless, each currency had some kind of parity against each other.
For example, before the crisis in 1997, the ringgit was roughly 2.5 to one US dollar, the Thai baht 25, the Filipino peso 25 and the Taiwan dollar also 25. In other words, they adjusted at roughly one or 10 to each other. This made it very convenient to do business across East Asian borders, mainly because of trade competitiveness.
Each central bank knew that if the rates moved out of line, not only against the US dollar but against the neighbours, there would be trade competitive issues.
This regional pattern of currencies “waltzing against each other” in a stable pattern unless disrupted by crisis was formed by the underlying Asian Global Supply Chain. After the Asian crisis, when most currencies floated, the same pattern emerged, because the underlying needs of the Asian Global Supply Chain forced some competitive stability between the linked exchange rates.
In sum, exchange rates ultimately reflect the underlying strength or weakness of the real economy. You can jazz up all you want through flexible rates, but ultimately if you overspend, you pay.
● Andrew Sheng is author of the book, From Asian to Global Financial Crisis.
Saturday, February 20, 2010
A welcome increase in the Fed discount rate
The short-term impact is negative, but a start has to be made towards making money more expensive
IT’S strange how markets react sometimes. The short-term, knee-jerk, downward reaction is often difficult to understand even when the long-term benefits are obvious, and events signal the start of normalisation of very unusual and adverse circumstances.
But it is likely that the stock market’s adverse reaction to the increase by the US Federal Reserve of its key discount rate by a quarter of a percentage point to 0.75% will be short-lived.
At the same time, it is also clear that stock markets may not see the kind of gains seen in 2009 when prices went up by about a half after the collapse of share prices in late 2008 following the world’s most serious financial crisis since the Great Depression of the 1930s.
Two things happened to the markets – stock prices headed south while the US dollar headed north. That is the right way to go purely from a short-term point of view and it likely reflects that although the Fed’s move was expected, it came a bit sooner than the market expected.
Higher interest rates – and this move by the Fed without a doubt presages that – mean that investors will demand a higher rate of return from their holdings. That implies that stocks and bonds will have to fall accordingly.
On the currency side, it implies that holdings of US dollar assets will soon enough get higher interest rates. Accordingly, the US dollar rose to a nine-month high against the euro.
But these are short-term effects. The trillions of US dollars that have been injected into the US and other economies and the loose monetary policies followed all imply that at some time, inflation will become a serious concern.
Easy, cheap money helps to turn an ailing economy around and boosts confidence but prolonging it can be dangerous. That the Fed sees it fit to change its stance now is positive because it must feel that the threats to the system have been largely diffused.
Even so, it is too early to pop the champagne and bring out the glasses. It’s a long walk out of the woods and the way is fraught with unseen hurdles and obstacles. The weather can change in a thrice and the path can get slippery. It calls for a lot of good, careful footwork.
For us in Malaysia, one must reasonably expect that interest rates will begin a slow climb upwards as well. The economy is recovering, the fiscal stimulus measures have bitten and growth is on the cards again.
Our economic problems were not anywhere near as serious as those in developed countries affected by the world financial crisis but we have our own set of problems and we need to work our own solutions to these – and fast.
The world does not stand still and once it sorts out its problems – and it is well on the way to doing it – it will continue its inexorable march onwards. We simply cannot afford to be left behind.
Eyes are focused on what new trick we can conjure up to bring forth a flourish of growth and opportunities to push incomes up for all of us. It will be interesting to see how much structural change will be made to the broad economy.
The march towards normalisation of the world economy, which has started, puts more pressure on us to put our house in order. Nothing less than radical change is required to make the necessary impact.
● Managing editor P. Gunasegaram believes in the old, paradoxical saying that change is the only constant or is it the only constant is change? Never mind, they mean the same.
IT’S strange how markets react sometimes. The short-term, knee-jerk, downward reaction is often difficult to understand even when the long-term benefits are obvious, and events signal the start of normalisation of very unusual and adverse circumstances.
But it is likely that the stock market’s adverse reaction to the increase by the US Federal Reserve of its key discount rate by a quarter of a percentage point to 0.75% will be short-lived.
At the same time, it is also clear that stock markets may not see the kind of gains seen in 2009 when prices went up by about a half after the collapse of share prices in late 2008 following the world’s most serious financial crisis since the Great Depression of the 1930s.
Two things happened to the markets – stock prices headed south while the US dollar headed north. That is the right way to go purely from a short-term point of view and it likely reflects that although the Fed’s move was expected, it came a bit sooner than the market expected.
Higher interest rates – and this move by the Fed without a doubt presages that – mean that investors will demand a higher rate of return from their holdings. That implies that stocks and bonds will have to fall accordingly.
On the currency side, it implies that holdings of US dollar assets will soon enough get higher interest rates. Accordingly, the US dollar rose to a nine-month high against the euro.
But these are short-term effects. The trillions of US dollars that have been injected into the US and other economies and the loose monetary policies followed all imply that at some time, inflation will become a serious concern.
Easy, cheap money helps to turn an ailing economy around and boosts confidence but prolonging it can be dangerous. That the Fed sees it fit to change its stance now is positive because it must feel that the threats to the system have been largely diffused.
Even so, it is too early to pop the champagne and bring out the glasses. It’s a long walk out of the woods and the way is fraught with unseen hurdles and obstacles. The weather can change in a thrice and the path can get slippery. It calls for a lot of good, careful footwork.
For us in Malaysia, one must reasonably expect that interest rates will begin a slow climb upwards as well. The economy is recovering, the fiscal stimulus measures have bitten and growth is on the cards again.
Our economic problems were not anywhere near as serious as those in developed countries affected by the world financial crisis but we have our own set of problems and we need to work our own solutions to these – and fast.
The world does not stand still and once it sorts out its problems – and it is well on the way to doing it – it will continue its inexorable march onwards. We simply cannot afford to be left behind.
Eyes are focused on what new trick we can conjure up to bring forth a flourish of growth and opportunities to push incomes up for all of us. It will be interesting to see how much structural change will be made to the broad economy.
The march towards normalisation of the world economy, which has started, puts more pressure on us to put our house in order. Nothing less than radical change is required to make the necessary impact.
● Managing editor P. Gunasegaram believes in the old, paradoxical saying that change is the only constant or is it the only constant is change? Never mind, they mean the same.
Thursday, February 18, 2010
Building Fit Minds Under Stress
ScienceDaily (Feb. 17, 2010) — A University of Pennsylvania-led study in which training was provided to a high-stress U.S. military group preparing for deployment to Iraq has demonstrated a positive link between mindfulness training, or MT, and improvements in mood and working memory. Mindfulness is the ability to be aware and attentive of the present moment without emotional reactivity or volatility.
To study the protective effects of mindfulness training on psychological health in individuals about to experience extreme stress, cognitive neuroscientist Amishi Jha of the Department of Psychology and Center for Cognitive Neuroscience at Penn and Elizabeth A. Stanley of Georgetown University provided mindfulness training for the first time to U.S. Marines before deployment. Jha and her research team investigated working memory capacity and affective experience in individuals participating in a training program developed and delivered by Stanley, a former U.S. Army officer and security-studies professor with extensive experience in mindfulness techniques.
The program, called Mindfulness-based Mind Fitness Training (MMFT™), aims to cultivate greater psychological resilience or "mental armor" by bolstering mindfulness.
The program covered topics of central relevance to the Marines, such as integrating skills to manage stress reactions, increase their resilience to future stressors and improve their unit's mission effectiveness. Thus, the program blended mindfulness skills training with concrete applications for the operational environment and information and skills about stress, trauma and resilience in the body.
The program emphasized integrating mindfulness exercises, like focused attention on the breath and mindful movement, into pre-deployment training. These mindfulness skills were to regulate symptoms in the body and mind following an experience of extreme stress. The importance of regularly engaging in mindfulness exercises was also emphasized.
"Our findings suggest that, just as daily physical exercise leads to physical fitness, engaging in mindfulness exercises on a regular basis may improve mind-fitness," Jha said. "Working memory is an important feature of mind-fitness. Not only does it safeguard against distraction and emotional reactivity, but it also provides a mental workspace to ensure quick-and-considered decisions and action plans. Building mind-fitness with mindfulness training may help anyone who must maintain peak performance in the face of extremely stressful circumstances, from first responders, relief workers and trauma surgeons, to professional and Olympic athletes."
Study participants included two military cohorts of 48 male participants with a mean age of 25 recruited from a detachment of Marine reservists during the high-stress pre-deployment interval and provided MT to one group of 31, leaving 17 Marines in a second group without training as a control. The MT group attended an eight-week course and logged the amount of out-of-class time they spent practicing formal exercises. The effect of the course on working memory was evaluated using the Operation Span Task, whereas the impact on positive and negative affect was evaluated using the Positive and Negative Affect Schedule, or PANAS.
The Positive Affect scale reflects the extent to which a person feels enthusiastic, active and alert. The Negative Affect scale reflects unpleasant mood states, such as anger, disgust and fear. Working memory capacity degraded and negative mood increased over time in the control group. A similar pattern was observed in those who spent little time engaging in mindfulness exercises within the MMFT group. Yet, capacity increased and negative mood decreased in those with high practice time over the eight weeks.
The study findings are in line with prior research on Mindfulness Based Stress Reduction, or MBSR, programs and suggest that MMFT may provide "psychological prophylaxis," or protection from cognitive and emotional disturbances, even among high-stress cohorts such as members of the military preparing for deployment. Given the high rate of post-traumatic stress disorder and other mental-health disturbances suffered by those returning from war, providing such training prior to deployment may buffer against potential lifelong psychological illness by bolstering working memory capacity.
In the several months prior to a deployment, service members receive intensive training on mission-critical operational skills, physical training and "stress-inoculation" training to habituate them to stressors they may experience during their impending mission. They also must psychologically prepare to leave loved ones and face potentially violent and unpredictable situations during their deployment.
Persistent and intensive demands, such as those experienced during high-stress intervals, have been shown to deplete working memory capacity and lead to cognitive failures and emotional disturbances. The research team hypothesized that MMFT may mitigate these deleterious effects by bolstering working memory capacity.
The study, published in the journal Emotion and also featured in the most recent edition of Joint Force Quarterly, the advisory journal for the Joint Chiefs of Staff, was funded by the John W. Kluge Foundation and the Department of Defense.
Jha was the principal investigator on the project, and Anastasia Kiyonaga, Ling Wong and Lois Gelfand from the Department of Psychology Penn's School of Arts and Sciences comprised her research team.
Stanley is the creator of MMFT and is on the Board of Directors of the Mind Fitness Training Institute, a nonprofit 501(c)(3) established to support the delivery of MMFT.
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