27th July 2007
The US dollar is a freely traded currency and its value is fixed by the market. It is the most important reserve currency offering international liquidity to finance international trade. Central Banks hold the largest portion of their reserves in US dollars and international commodities are generally priced in US dollars.
There is pretty little that monetary authorities can do to influence the value of their currency on the foreign exchange markets, although they do sometimes attempt to influence the markets by direct or verbal intervention.
Why should we care whether the dollar rises or falls? Simply because we import a lot of stuff priced in USD, most notably all our energy requirements, so the value of the dollar has a direct impact on the Maltese lira (or euro) cost of such things as vital to our life as fuel for our cars, machines and electricity generation or wheat for our daily bread.
The more the dollar falls, the cheaper in Maltese lira terms will be these important imports. So the fall in the
The value of the USD is not fixed by the markets in isolation. If the dollar falls on the foreign exchange markets, then some other currencies are compensating by rising in value. Recently it was the euro, the pounds sterling and the Canadian, Australian and
Why have currencies behaved so differently in so far as their US dollar values. For those currencies that are not freely convertible, especially the Chinese renminbi, the move in sympathy with the
The value of other currencies that are freely traded are influenced by their level of the rate of interest and their position on the economic growth cycle.
So the Japanese yen has fallen against the USD dollar as Japanese interest rates are still very low and their economic growth following a decade of deflation is still fragile, as it is dependent on such low exchange rate for the yen to keep propping up demand for Japanese exports.
The strength of the Canadian, Australian and
The enigma is more related to the euro. Why has the euro increased so much in value against the
I can think of two reasons for this. The euro is gracefully establishing itself as an international reserve currency second only to the US dollar. The more the US dollar falls, the more motivation international central banks will have to diversify their resources away from the US dollar, thus creating additional demand for the euro and additional supply of the USD as a direct result of such portfolio shifts rather than as a result of normal trade flows. The second reason is that European monetary are not totally displeased with the euro’s strength, as it neutralises the increase in the US dollar cost of energy and commodities.
But there is a limit as to how much the euro can go up and how much the US dollar can fall. And this week we must have come very close to that limit. Further increases in euro value in dollar terms will start hurting European export potential and will give more credence and support to French President Sarkozy’s claim that the European Central Bank cannot continue operating monetary policy in total disregard to the euro’s external value. If the euro remains this strong, the European Central Bank will be hard put to justify further euro interest rate increases. The bond markets can sigh with some overdue relief.