Wednesday, October 26, 2005
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How long can the fundamentalists be wrong?
When it comes to predicting exchange rates, there are chartists and fundamentalists. The former focus on short-term price trends and try to win the "predict everyone else's expectations" game. The latter look at underlying economic fundamentals to figure out where the exchange rate will inevitably head.
When it comes to the dollar's performance in 2005, chartists are beating fundamentalists. The Economist's Buttonwood column tries to explain why:
The question is how long the chartists will stay bullish on the dollar. Speaking for the fundamentalists, New York Fed President Timothy Geithner is not optimistic (link via Brad Setser):
Geithner also touches on one of the big questions that I can't answer -- why the United States has such a comparative advantage in consuming goods and services:
it's not even clear that policy reforms of the sort Geithner is talking about will be sufficient in the Pacific Rim -- past crises have made that region loath to consume. Click here for more on the puzzle of Asia's lack of domestic consumption.posted by Dan on 10.26.05 at 11:37 AM
For an engaging description of the inability of fundamentals to exchange fluctuations over a time horizon of less than about 2 years, see "The Microstructure Approach to Exchange Rates", by Richard Lyons, 2001.
I am a fundamentalist but bullish on the dollar. We should treat human capital, and demographics, and economic policy, as part of the relevant fundamentals. The bears look too much at just the current flows.posted by: Tyler Cowen on 10.26.05 at 11:37 AM [permalink]
It seems to me the pattern has been pretty straightforward since I've been watching it -- the last 25-30 years. The Fed tightens, the dollar rises. The Fed loosens, the dollar falls. There are probably good fundamental reasons, the comparison with other investments being the main one. And if the Fed tightens, the expectation among investors that the dollar will rise and thus increase the value of dollar denominated investments is self-fulfilling, which may be a chartist reason.posted by: John Bruce on 10.26.05 at 11:37 AM [permalink]
Tyler -- if you want to go long the dollar v. the renminbi on "fundamental" grounds, i am happy to take the opposite side of that trade. The US does have some fundamental strengths, but I don't see much evidence that we currently are investing in either the kind of physical or human capital needed to allow the US to easily increase our exports sufficient to keep the current account deficit from widening at current levels of the dollar. But tis entirely possible that my threshholds for debt/ GDP and debt to exports (external debt) are off, and the US net ext. debt will rise to say australian levels before the markets (or the Chinese central bank) demands adjustment.
Dan -- i was too slow to put my reactions to buttonwood; you beat me to it.posted by: brad setser on 10.26.05 at 11:37 AM [permalink]
The recent strength of the dollar is tied to the implosion of the Euro, if you ask me. Western Europeans had their world shattered a couple months ago, when it became obvious that the Euro governments would never work together as had long been envisioned, dooming that currency in the long run...posted by: L. B. Hughes on 10.26.05 at 11:37 AM [permalink]
People and investors put the money where there are more trust and dynamism. If you want dynamism go to India, China, and markets that can grow easely. If you want safety and "standart" grow put money in USA or some good European firm. Since Europe (Germany France , UK is going down too) isnt growing much and futur perspectives doesnt seem good either even for buying cheap yet.The Dollars assets are here to stay for now.
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