Category Archive: FX Theory

05 FX Theory

9. The Holy Grail of Long-Term Currency Movements: Crowther’s Balances and Imbalances of Payments

The former chief editor of “The Economist” Geoffrey Crowther published a great work on the development of balance of payments and current accounts over the long-term. It divides development into six phases, which are analogous to Shakespeare’s seven phases of life.
The seven stages are:
Young debtor nation, Mature debtor nation, Debt repayment nation, Young creditor nation, Mature creditor nation, Credit disposition /Asset Liquidation nation and the back to start stage

Permanent link to this article: http://snbchf.com/fx-theory/crowthers-balances-imbalances-payments/

The Euro is Poised for a Rise, Expect $1.50 in 2 to 4 Years

We present twelve reasons that could sustain a further euro appreciation to $1.40 or even 1.50 in the upcoming two to four years. The main one is that Germans are net global creditors and Americans net debtors. This is reflected in fiscal and monetary policy and in investors’ behaviour. The post was written in December 2013, but the arguments are still valid today and will continue to be valid in the future.

Permanent link to this article: http://snbchf.com/fx-theory/eurusd-1-50/

5.2. FX Theory: Penn Effect and Balassa Samuelson Effect

George Dorgan extends the previous discussion on trade surplus countries. Now he explains the Penn and the Balassa-Samuelson Effect. He applies these principles to Germany, to Greece and to Switzerland.

Permanent link to this article: http://snbchf.com/fx-theory/penn-effect-balassa-samuelson-effect/

5.1. FX Theory: The Trade Surplus and the Real Exchange Rate Mean Reversion

George Dorgan explains why currencies of countries with trade surpluses must appreciate over the long-term. Thanks to these surpluses, inflation and costs of companies rise more slowly than in other countries. In Forex a mean reversion does not exist, but only an inflation-adjusted reversion to the mean: a real exchange rate mean reversion or in short the “real mean reversion.”

Permanent link to this article: http://snbchf.com/fx-theory/real-mean-reversion/

5. The Balance of Payments Model

The balance of payments leads to many confusions because definitions vary. Essentially the balance of payments do not reflect payments, i.e. accounting entries. But it is a flow model, similar as cash flow analysis for companies.
For example, the IMF’s definition is different from the usual or historical definition. Secondly, the relationship between the balance of payments and reserve assets is difficult to grasp, especially in the IMF definition. Thirdly the origin of “errors and omissions” is often unclear. Therefore we give an explanation in around 400 words, that clarifies the relationships.

Permanent link to this article: http://snbchf.com/fx-theory/balance-of-payments-model/

2.6. CPI-based Real Effective Exchange Rate Since 1965: Yen Still Most Overvalued Currency

If we calculate Real Effective Exchange rates on the base year 1965, the Japanese yen remains the most overvalued currency.
This analysis is based on the real effective exchange rate (REER) provided by the Bank of International Settlement (BIS) and a consumer price-index adjusted exchange rate.
The real value of the yen is around 50% higher than 1965, the same applies to the Swiss franc.

Permanent link to this article: http://snbchf.com/fx-theory/real-effective-exchange-rate/real-effective-exchange-rate-since-1965/

6.6 The Ultimate Carry Trade: U.S. Banks Buying Treasuries

Continue reading »

Permanent link to this article: http://snbchf.com/fx-theory/carry-trade-u-s-banks-treasuries/

12. FX Rates, Contrarian Investments and the Misleading Concept Called GDP

We extended our existing post to contrarian investing. It was published on Seeking Alpha and awarded the Editor’s Pick.
Gross Domestic Product(ion) is (or has become) a measurement of activity and consumption, but not of capital accumulation and production.
In many cases, GDP growth is negatively correlated to saving. Higher savings (aka austerity) leads to lower GDP growth today, but to higher GDP in the future.
In its worst case, GDP growth could be completely based on credit, eliminating the capital basis of a country (example Greece).
FX rates are less driven by GDP but by savings and investments, in particular on the corporate side, by investors and micro-economic indicators.
In addition to micro-economic indicators like price to cash flow or price to book ratio, the saving rate is the best macro-economic indicator of the investment style called “contrarian investing.”

Permanent link to this article: http://snbchf.com/fx-theory/fx-rates-contrarian-investing-misleading-concept-gdp/

10.1.1. Net International Investment Position United Kingdom

We discuss the net international investment position of the United Kingdom

Permanent link to this article: http://snbchf.com/fx-theory/wealth-niip/net-international-investment-position-united-kingdom/

10.1.2. Net International Investment Position Switzerland and Italy

We compare aspects of the Net International Investment Positions for Italy and Switzerland

Permanent link to this article: http://snbchf.com/fx-theory/wealth-niip/net-international-investment-position-switzerland-italy/

10.1 Net International Investment Position

A comparison of the net international investment position (NIIP) of several countries. We explain why asset valuation effects this position at the example of the United States.

Permanent link to this article: http://snbchf.com/fx-theory/wealth-niip/net-international-investment-position/

5.2. FX Rates, the Balance of Payments Model and Central Bank Interventions

We will apply the balance of payments model for determining FX rate movements and FX interventions by central banks.

Permanent link to this article: http://snbchf.com/fx-theory/fx-rates-balance-payments-model-central-bank-interventions/

13. Germany and the Currencies in Northern Europe

German spending is one factor that drives currencies in Northern Europe.

Permanent link to this article: http://snbchf.com/fx-theory/germany-currencies-northern-europe/

2.1. OECD Purchasing Power Parity Index

The OECD purchasing power parity compares consumption prices in different countries.

Permanent link to this article: http://snbchf.com/fx-theory/purchasing-power-parity/oecd-purchasing-power-parity-index/

2.2. Purchasing Power Parity: Big Mac and Starbucks Tall Latte

The following table compares the Big Mac and the Starbucks Tall Latte index among different countries. It explains the issues with these measurements.

Permanent link to this article: http://snbchf.com/fx-theory/purchasing-power-parity/purchasing-power-parity-big-mac-starbucks-tall-latte/

2.3. Differences in global CPI baskets

Typically poorer countries have a basket with a higher weight for food and other consumption goods, but richer states give them a smaller weight. Here the full details over different countries

Permanent link to this article: http://snbchf.com/fx-theory/purchasing-power-parity/differences-cpi-baskets/

7. FX Theory: The Asset Market Model

The Asset Market Model implies that a currency will be in higher demand and should appreciate in value, if the flow of funds into financial market of the country such as equity and bonds markets increase.

Permanent link to this article: http://snbchf.com/fx-theory/the-asset-market-model/

2.7. The Most Complete Real Effective FX Rate Comparison

In August 2013 the Bruegel blog offered one of the best comparison of long-term real effective exchange rates (REER). The data is CPI based and therefore not as good as the producer price index (PPI) that reflects tradable goods better.
However the data is huge with three different sources – BIS, World Bank, Eurostat, OECD and Bruegel. The data indicates how the real value of the currencies of China and many other Emerging Markets (EM) have improved against 1995. In order fulfill basic needs like food, transportation and housing, this expansion required more and more commodities. By consequence the commodity producers Canada, Australia, New Zealand, Russia, Brazil and OPEC countries but also less known oil producers like Angola, Guatemala, Honduras, Sudan went into a boom.

Permanent link to this article: http://snbchf.com/fx-theory/global-cpi-reer/

1.1. Currencies: Asian vs. American bloc

Permanent link to this article: http://snbchf.com/fx-theory/what-determines-fx-rates/asian-bloc-american-bloc/

9.1. Yen Weakness: Risk-Off Environment, Abenomics or Trade Deficit?

The yen overshot during and after the financial crisis. The USD/JPY fell from 120 in 2008 to lowest levels of 74, by 62%, but rose to 102 again. What are the reasons?

Permanent link to this article: http://snbchf.com/fx-theory/yen-weakness/

Page 112