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    A Double bubble ...


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    Join date : 2009-07-31
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    A Double bubble ... Empty A Double bubble ...

    Post by Nik on Sat Dec 26, 2009 1:46 pm

    A Double bubble ......... (As appreared in DNA Thursday, November 26, 2009)

    In their bid to keep exchange rates stable, central banks are fuelling another bubble

    Vivek Kaul. Mumbai

    “So how do we de-addict?” she asked as I sat down for tea after a hard day.
    Trust her to ask the wrong question at the right time, I thought, but kept my calm. “You know, relationships are like investment bubbles. The bigger a bubble grows, the more money an investor makes. Similarly, in a relationship, the better we know each other, the more fun it is. But the trick in a bubble, in order to make money, is to get out at the right time, a little before it bursts,” I said.
    “Investment bubbles? Where are we really heading towards V?” she asked.
    “Thats exactly what I am trying to answer — where are we heading towards? So let me get into what right now might seem like irrelevant stuff, but you will understand as we go along. I am sure you must have heard about the dollar carry trade by now.”
    “Yes I have. The Federal Reserve, the central bank of the US, has cut interest rates to almost zero percent. This has been done in the hope that Americans start borrowing money again and buy stuff with it. That would hopefully revive the flagging economy. But that hasnt happened. Instead, speculators have entered the picture, borrowed money in dollars at almost zero percent rates, and invested that in stock and commodity markets all across the world. It is this money that is driving stocks up all over the world,” she replied.
    “That tells me you have been listening to me very carefully all this time. Now lets try and get a little deeper into the dollar carry trade. Let us say an investor borrows in dollars and wants to invest in the Swiss stock market. What will he do?” I asked.
    “Convert his dollars into Swiss francs and invest in the stock market.”
    “Correct. Now what will be the impact if a lot of investors turn up with dollars wanting to convert them into Swiss francs?”
    “The demand for Swiss francs will go up and its value against the dollar will go up.”
    “Right. Thats precisely what has happened. Since March this year, the Swiss stock market has gone up around 45% and the Swiss franc has gained against the dollar. At the beginning of March, a dollar was worth around 1.16 Swiss francs. Now, one US dollar is equal to one Swiss franc. So what does that tell us?” I asked.
    “It tells us that as all the carry trade money has come in, the demand for the Swiss franc has gone up. Hence, it has gained in value against the dollar. So less of Swiss franc is available for the same value of dollar,” she explained.
    “Over the years the Swiss National Bank has been very disciplined in trying to maintain the value of the Swiss franc. And this is why the Swiss franc is counted among the five top reserve currencies of the world along with the British pound, the euro, the Japanese yen and of course, the US dollar. One sure shot way of maintaining the attraction of a currency as a reserve currency is not to go on a printing spree. The Swiss National Bank has been practicing that and over the years has increased the money supply at the rate of 3% every year. But in the recent past, this policy measure has been dropped. In the last one year, the money supply has been increased at the rate of 8% to ensure that the Swiss franc gains less against the dollar.”
    “Oops.What was that?” she asked.
    “See, as dollars borrowed under the dollar carry trade come into the country, the demand for the Swiss franc goes up, leading to an increase in its value against the dollar. Now, when a currency gains in value against another currency, exporters suffer. It is like this, if an exporter in Switzerland earns $1,000 when 1$ = 1.16 Swiss franc, then he makes 1,160 Swiss francs. But if 1$ = 1 Swiss franc, then the exporter makes 1,000 Swiss francs, a loss of 160 Swiss francs for him. Any government would like to protect its exporters, either by trying to maintain the exchange rate against a major international currency or by at least slowing down the pace of its gains. How can it do that? It can do that by ensuring that there are enough Swiss francs in the market when the carry trade investors come with their dollars. How do they do this? By printing more Swiss francs and putting them into the market. This, depending on the amount of currency that is printed, ensures the Swiss franc gains slowly against the dollar than it would have without the money printing,” I explained.
    “Pretty complicated, but I think I get it.”
    “That is why the Swiss authorities, who normally increased money supply by 3% per year, have increased it by 8% in the last one year. But there is a twist to this. This extra money that is printed also goes into speculation in the stock market and other markets, and is part of the reason why the Swiss market is up by around 45% since March.”
    “Where else is it happening?”
    “China is another good example. The value of the Chinese yuan is fixed against the dollar. It does not vary as the value of other currencies against the dollar does. Currently one dollar is equal to 6.84 yuan.”
    “But how is that? If the dollar carry trade money is coming into China, logically, the demand for yuan should go up against the dollar. And that in turn should increase the value of the yuan against the dollar. Shouldnt it?” she asked.
    “Theoretically you are correct. But what happens is, the Chinese central bank has cranked up its printing presses. Chinese money supply has increased by around 29.4% in the last one year. This ensures that even with all the dollars coming in, the demand for yuan stays stable. protecting Chinese exporters. But the fall out of this is that a lot of this newly printed money is leaking into the stock and real estate market in China, taking them to even greater levels. Another great example is Hong Kong, which has printed and injected HK$546 billion into the foreign exchange market in the last 12 months. This again is largely to offset the huge demand for Hong Kong dollars by the carry trade investors. This has ensured that one USdollar continues to be worth HK$7.8. And I need not tell you a lot of this newly-printed money has landed up in the stock market for speculation,” I said.
    “So what you are saying is that first the money coming in through the dollar carry trade route is pumping up the stock, real estate and commodity markets all over the world. Two, the money being printed by various central banks all over the world to ensure that the value of their currency doesnt shoot up too much against the dollar is also at some level getting diverted for speculation purposes. This in turn is pushing these markets higher and higher.”
    “Yes, dear. Thats what I am saying.”
    “And what about relationships being like a bubble?”
    “Oh, that I thought was self-explanatory. For any investor to continuously make money, he needs to successfully keep identifying which is the next big bubble and get out with the money before the bubble bursts.”
    “So are you saying that in a relationship, there comes a point when we know each other so well that the relationship is about to split and so it makes sense to split?” she asked.
    “No. What I meant was that for a relationship to keep growing, we should be able to search for the next big bubble. You know, some aspect that we dont know about each other... something that we might like doing together until it is time for the next bubble.”

    (The example is hypothetical)

    A Double bubble ... Empty Re: A Double bubble ...

    Post by Guest on Wed Oct 19, 2011 3:50 pm

    Thanx for sharing it

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