Dollar vs. Euro

Following my post: "Why is the Euro doing so well...", a reader asks:

What about the other currencies, it's not just the dollar. Banks have started switch more and more of there reserve currency from the dollar over to the euro.

Good question, so instead of answering in the comments section, I thought I'd do a post. So here's my reading on the situation:

First off, it is not that the USD is just doing poorly against the Euro, it is also faring badly against other currencies as well. I hail from Canada so US$/C$ exchange rates are always of interest. I can tell you that going back up to Toronto to visit friends and family isn't as cheap as it used to be. Friends and family now view us as the poor American relations coming North to mooch off of them.

US$/C$ parity was such a momentous occasion, I actually remember where I was when I first learned of it back in September.

In regards to the question of banks switching over reserve currencies to the Euro, I think the reader is referring to a number of countries, namely China, using a basket of currencies (rather than just the USD) either as a reserve or as a peg.

The reason here is diversification. The dollar is tanking so if you're holding a large amount of dollars (as China is), then your holdings are rapidly declining. If you want to stabilize your holdings and diversify away some of your risk, then you’d want to start holding other currencies.

Essentially all of your value/risk is tied up with one currency and in the current environment, if that currency is the USD then you’re not feeling as rich as you once did.

If you’re pegged to the USD (meaning your local currency has a fixed exchange rate to the USD), then the value of your currency is also declining. For countries that import a lot, a declining currency is putting yet more very unwanted upward pressure on prices. This is particularly worrisome in the Gulf countries where the influx of oil money and their declining dollar-pegged currencies are contributing to huge increases in inflation.

The next question usually is, will the world move off the USD as a reserve entirely? Not likely, IMHO. Too many things are still priced in dollars and the dollar-as-global-reserve is too ingrained in the current system. It would take a huge calamity, greater than the credit crunch we are currently facing, to move the world off the dollar-reserve.

Galbraith, the new Friedman?

With the credit crunch and the looming recession, there seems to be a growing demand (and apparent appetite) for increased regulation (heck, even the Bush administration has gotten on the activisit government bandwagon)

For the last 20+ years, the patron saint of economic thought in the US was Milton Friedman. But given the above observations, and given that people like Greg Mankiw are linking to reviews of John Kenneth Galbraith (although there probably is not any implied endorsement of the reviewed ideas), I cannot help but think, in what I believe is a coming age of more liberalism in the US, will Galbraith be the new Friedman?

Consolidating the blogosphere

TechCrunch asks whether 'tis nobler in the mind to take the slings and arrows of venture capital, or take arms against a sea of excessive valuations and by opposing them, consolidate the market!

Ethanol and protectionism

I heard on the radio the other day about how the increase in the general price of food is being traced back specifically to the increase in corn prices. The logic is that corn is an important source of animal feed so as it becomes more expensive, there is a ripple effect that drives up the price of feed which in turn drives up the price of meat.

The cause of the rise of corn prices? Apparently it is ethanol. Because of the alternative fuel craze, ethanol producers are gobbling up supply of corn and driving the prices up. To venture backed ethanol companies, this rise in prices may not seem like such a big deal (and the farmer certainly love it!) But for the rest of us who like to eat, a rise in food prices is yet another dent in our already banged up wallet.

And with that, the two radio shock jocks went on to slam ethanol, the environmental movement, and the whole green craze for causing more trouble that it is worth.

Taking what they said on the connection between corn and food prices at face value (certainly seems plausible), it is still hard to blame ethanol producers for the run up in corn prices. This is not a green question, this is an economics question.

Agriculture is a heavily protected industry in the US (and much of the world.) As a move to boost farmers’ incomes in the Midwest, the US government has been supporting and protecting the US corn-based ethanol business.

There are however rivers of cheaper sugarcane-based ethanol coming out of Brazil. If the government were to relax protection, these rivers would flood into the US market. The result would be cheaper ethanol that would displace the more expensive corn-based ethanol. This in turn would reduce demand for corn and prices would drop. So if the market was allowed to operate unencumbered, we would have cheaper food and cheaper ethanol.

So if the shock-jocks on some random Bay Area radio station are listening, it is not ethanol or environmentalism that is driving up prices, it is agricultural protectionism.

"Why is the Euro doing so well..."

...a European friend recently asked me.

"It isn't," I replied with a sigh. "It is just the US dollar is doing particulalry poorly.

A Board of Advisers for Your Life - Shifting Careers - Small Business - New York Times Blog

interestint thought

For the Fed, a Recession -- Not Inflation -- Poses Greater Threat - WSJ.com

Can't think of any commentary at the moment... but take a minute to go through this, it is a good read.