Sunday, November 18, 2007

One more piece of the puzzle

One more piece of the exchange rate puzzle came to light on Friday morning, one that is even more fundamental than interest rate differences. The US Department of the Treasury publishes a set of figures monthly known as TIC, or Treasury International Capital. These figures are a measure of the capital that is flowing in and out of American markets.

Capital flows around the world constantly. In international trade it's mostly US dollars of course, but that is slowing changing. Products, or goods are also flowing around the world and in terms of the "dollar value of goods" America has been running a deficit for, well, forever. The value of goods arriving on American shores far exceeds the value of the goods being exported.

The difference in the value of those goods can be made up in capital that returns to America, invested from abroad. Recently though, the in-flowing capital isn't even coming close to making up the trade deficit, and the exchange rate of the dollar has been suffering as a result.

Here are a couple of links, and a couple of good quotes.

"These data confirm the U.S. is not financing its current account deficit with foreign portfolio inflows and this is pressuring the U.S. dollar."

"...Treasury International Capital data sparked the renewed dollar sell-off, as a mere $26.4 billion in net foreign investment entered the US through the month of September. Given consensus forecasts of a $60.0B gain, the result was hardly enough to quell fears of further foreign divestment of US financial assets."

The big fear in the dollar markets is that the biggest holders of dollars (the Chinese basically) could start to sell some of their holdings in favor of a stronger currency like the Euro. In reality, they don't have have to sell a thing. If the Chinese were simply to "re-invest less" of their trade balance in the US markets, the exchange rate of the dollar would come under huge pressure and apparently that is exactly what is happening. That $60.0B figure quoted above wasn't just picked from the air. That is the amount that America needs in order to fund its trade deficit. That comes out to 2.0 billion dollars per day! That figure is almost insane.

The Euro has gone parabolic lately, but I'm not calling any sort of a top here. No matter what happens in the interest rates of the various central banks, unless capital starts flowing more readily into the American markets, the exchange rate of the US dollar will continue to suffer.

Disclosure: I own FXE Mar08 calls.

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