Clear thinking about currencies can make a lot of money — remember George Soros’ billion-dollar day pushing the Bank of England over the edge of devaluation, back in the day. I have neither the bucks nor the nuts to play that game, but still I like to understand stuff that seems complicated. (A quick Soros story: Among the interview questions for prospective traders for his Quantam macro hedge fund was this: “Imagine that you a certain of a major market move. How big a position do you take?” Now, all your wealth is tied up in the fund, along with that of all your peers and investors, not to mention your professional future and your good name. How big a risk do you take? The only acceptable answer was “All of it”. If you’re certain, put down all the chips. Diversification is for low-risk wimps, go work at a mutual fund or something.)
Just to show that I don’t understand, here’s an Economist piece (subscription required I think) about US foreign debt falling, despite the high current account deficits. A puzzlement. Here’s the main explanation (after noting the outperformance of foreign stocks):
Even more important over the past three years has been the impact of a cheaper dollar. About 70% of America’s assets abroad are denominated in foreign currencies, so when the greenback falls, their dollar value rises. Meanwhile, as the home of the world’s main reserve currency, America has the advantage that virtually all of its foreign liabilities are in dollars, so that the currency’s depreciation does not increase their value. Thus a fall in the dollar boosts America’s net wealth.
So devaluing your currency makes you richer? Why didn’t anybody tell me that before? Seems like it would have been good to know. And this game of compensating huge deficits by devaluing your external debt, how long can that last?
Being a reserve currency helps. One piece about the China announcement, the importance of which doesn’t seem to be getting heavy press play, is that the trading band is against a basket, not just the US dollar. In other words, at least in one respect, and as far as China is concerned, the USD has just been cut from its reserve currency status. Reserve currencies don’t change overnight, but they do change. Gold is gone, eg. And the German mark was as a reserve currency for awhile, for some countries, back when there was a German mark. How much longer will the USD be a reserve currency? And what will the consequences be of its loss of status?