Help! This non-maths person is very confused about the dollar vs the pound

[enlightenment]

I'm an historian. I can speak intelligently about many things . . . but I don't understand economics at all, I guess.

Why, when our economy is (presumably, at least in terms of Wall Street psychology) improving, does the dollar weaken against other currencies?

To my non-maths brain, it would seem logical that the dollar would be worth more, not less. I kind of get the whole trade deficit thing, but is that all it is? That a stronger dollar actually makes it worth less to other countries? I read today that Heinz Co. lost money because the stronger dollar made their products more expensive to buy in other countries, once the sales were translated back to dollars but in essence, that's because the dollar isn't worth as much, right? So the price of Heinz baked beans in England went up because the company couldn't make a profit at the price they were selling them - and fewer people bought the beans because they were more expensive. I get that - but I still don't understand why presumably GOOD news on the US economic front makes the dollar worth less against other currencies.

Would one of you knowledgeable people please explain it to me? In very simple language, please (because I really am clueless, I don't invest, and I read the financial pages mostly to see how much I don't understand . . .)

Thank you in advance!

[MineralMan]

1. It's all so simple, really...

A dollar used to buy a pound of hamburger. Now it doesn't

[enlightenment]

3. Not really helpful, but thank you anyway. :) nt

[Nicholas D Wolfwood]

2. One thing you aren't considering...

Our economy doesn't sit in a vacuum, which is to say that while our economy may be improving, other nations' economies might be as well. You may not have noticed, but as our economy started its slide, the value of the dollar actually improved against the Euro because the European economy, likely because the collective European economy was doing similarly poorly.

In other words, the value of the dollar is a better indicator of relative strength rather than strength in isolation. That our economy is getting better while the dollar is getting worse is less a reflection of the U.S. economy alone but rather a reflection of how well we're doing compared to other nations.

[enlightenment]

5. Well, I am considering that - but that's not really the question.

I'm sure I didn't phrase it well.

I understand that other economies may be 'stronger' against the dollar, but what if they're not?

From what I can tell, the UK economy is struggling. Their 'recovery' is not proceeding as quickly as ours (all being relative, etc, etc - and mostly smoke and mirrors I suspect). Logically, if our economic indicators are 'better' than theirs, the cost of buying a pound should be less (at least that's logical to me and that's why I'm confused).

Instead, for every report that comes out saying we're doing better - relative to them - the gap widens.

Does that make my question any more clear? I know it's murky and poorly phrased and I apologise. I just don't have the terminology knowledge to be more specific.

[Statistical]

16. DEBT DEBT DEBT DEBT

The exchange rate is simply the price of a currency (in another currency).

Just like anything else if it is in demand then price rises.
If it is in low demand the dollar weakens.

There are many thing that change demand for the dollar (or other currencies)
Exports (to buy US goods you need $$$. If more people want it those "selling" $$$ can charge more for them)
Stability (when looking to not lose your principle you want a stable country)
Inflation (inflation is the killer of wealth. the risk of fear of inflation weakens the $$$)
Economic Output (to buy US stocks you need $$$. More people wanting to invest in US increases value of $$$$)

Massive deficit spending is a risk to future economic growth (which also affects exports), increases the risk of default, and increases inflation.

As people get concerned about our inability to manage debt they flock to other currencies weakening the $$$.

[On the Road]

4. It Has to Do Not Just With Economic Performance

but with how the currency is managed. Countries with low inflation and low debt levels are likely to see their currency valued highly. In the US, Republican deficits have resulted in rapidly growing government debt. Obama has added to the debt in an attempt to deal with the economic crisis.

Another factor is demand for the currency. When a country has strong exports in its own currency, demand for the currency increases and the value rises. The US with its trade deficit is in the opposite position.

It is also about economists and investors' expectations for the future. Day-to-day changes in exchange rates are a lot like the stock market, based on speculation and a mix of different buyers and sellers who have different reads on the economic future.

You also have to take into account that there are two sides to every exchange rate. It is not simply a judgment of the US, but also the other currency. The Euro is strongly influenced by German financial conservatism and puts limits on its members budgets etc and is seen by many people as a sager haven than the US dollar. The US has been more profligate.

Strong currency is not always a good thing. Conservative finances may reduce growth and increase unemployment, for example. China has deliberately weakened its currency for years to make its exports cheaper, which has been a tremendous success for them.

But I don't really understand the details of currency markets that well. There may be others here who can add a lot more.

[enlightenment]

6. That helps a little, thank you.

I understand how governments can manipulate the currency (i.e., China and the Euro) and I think I get the trade deficit thing . . . but I'm still confused - which may be a permanent condition. sigh.

[On the Road]

7. I Can Assure You That 99% of Americans are Confused, Too

I have an MBA, follow the stock market, work as a Finance Manger for a large corporation, and still don't have a very good grasp of currency markets. For example, I don't understand what China does to keep the Yuan so low.

The kind of questions you're asking are putting you in a better shape to have an opinion that the majority of Americans.

[enlightenment]

8. Thank you for the kind words - though I think I'll refrain from

having an opinion on it. Can't think of a better way to hoist myself by my own petard!

[On the Road]

12. What Most People Who Seem Knowledgable Actually Do

is to pick up on the things that affect a currency -- trade deficit, growth in the budget deflicit, inflation, etc -- and just go from there without understanding exactly what goes on under the hood.

It's not exactly a fault, but many people new to economics feel the need to understand the exact mechanisms. Not that it's bad to know that, but it's unusual and you can go a long way without it. Same goes for things like inflation.

[leahcim]

9. Re: very confused about the dollar vs the pound

At this point, it's not a one currency vs another thing, it's a safe-haven vs risk thing.

Currencies obey the usual laws of supply and demand: If a lot of people want to buy a currency, the value goes up. If a lot of people want to sell it, the value goes down.

When the market tanks, people take their money out of the stock market and put it into safe investments. Despite everything else, US Treasuries (US government debt) is considered one of the safest investments in the world (albeit one that does not give a good return). When the market goes down people take money out of the market and buy US Treasuries. To do that they first need to get some US dollars to pay for them with, and if the money they took out of the market is in another currency, they need to buy some US dollars to do that. That drives up demand for US dollars, which drives up the price relative to other currencies.

Now that the economy is doing better, and people are more wanting to take risks, the opposite is happening. People who had their money in the safe haven of US treasuries, now are selling those treasuries, taking the US dollars they made from the sale, and buying stocks with them. If the stocks they want to buy are denominated in a foreign currency, then they have to sell the US dollars and buy the foreign currency. That increases the supply of US dollars on the market, which drives down the price.

There are plenty of other factors, like expected inflation from the stimulus spending and bank bailout which actually increase the supply of US dollars in the world, but that's the general gist of how it works in ordinary time.

[Celebration]

14. Ding, ding, ding

Right on point and answers the OP in a very direct and correct way.

[Art_from_Ark]

17. It's not necessarily "when a lot of people" want a currency

but rather when major holders move out of one or more currencies into one or more other currencies. "A lot of people" probably won't have much affect on currency markets if they are just buying foreign money for a trip or dabbling in the currency markets. It's really the big players who decide, the little guy just goes along for the ride.

[SheilaT]

10. Sometimes the exchange rate with another

currency simply does not make sense.

In 2001 I went to Australia, and their dollar was very weak against our dollar and I have no idea why. What I did know was that for every dollar U.S. I got two dollars Australian. And prices for virtually everything were, in Aussie dollars what I'd have expected to pay in U.S. dollars, so basically the country was on sale, half price. For instance, I got rooms in a decent hotel in Sydney for just under Aus$100.00, so I was paying about fifty bucks American. You can hardly get a room at the Motel 6 for that amount, let alone a room in a big city. The cost of food was again, in Australian dollars the amount I'd expect to pay in U.S. dollars. Souvenirs the same. I bought a wall clock in the shape of the country for ten of their dollars. It went on and on. And believe me, everyone I came into contact with was very aware that our dollar was worth so much more than theirs.

[tio]

11. Ooh a rabbit hole!

A lot of confusion may be found here, especially under the 'Determinants of FX Rates' section ...
http://en.wikipedia.org/wiki/Foreign_exchange_market

As horrifically complex as the FX markets look in the above article the currencies and therefore the nations these pieces of paper represent appear (nominally) to be self contained entities that are valued and speculated upon as such. The previous answers about market forces, flight to safety and the rest are accurate but won't clue you into why you might find dollar currency movements potentially counter intuative.

The layer that is rarely mentioned is the geopolitical/geostrategic nature of the dollar as the world reserve currency as established by Bretton Woods I. What this meant was that most global markets (commodities etc) ended up denominated and traded in dollars, that is, the actual transactions require dollars to complete. This dollar status permits the US many potential trade advantages for example in recycling petro dollars, however it also means that large swings in sometimes non US markets produce supply and demand issues for dollars not directly pertaining to the US economy itself. Another consequence is the so called flight to safety in Tbills as covered by a previous poster, this means that people park their capital in short term treasuries if they wish to abstain from speculating abroad and then reliquify these when re-entering other markets. There are other things but I hope you get the idea.

Also be aware that since the adoption of floating exchange rate mechanisms in the '70s and the wholesale 'finacialisation' of the FX markets every conceivable underhand and nefarious activity (naked short selling to outright fraud) prevalent in the so called free markets (an oxymoron) is present in FX markets. These market activities are driven by motives from the purely speculative (hedge funds) to the wholesale economic subjugation of whole peoples by supra national entities (IMF etc). In other words FX (or any other) market movements may have very little to do with market forces as most people understand them. Can you imagine a dollar CDS cascade/unwind notionally valued in fifteen figures?

Hope this helps a bit.

[Art_from_Ark]

18. I'll agree

"In other words FX (or any other) market movements may have very little to do with market forces as most people understand them."

This helps to explain why the Japanese yen was bouncing around like a yo-yo in the '90s, going from 131 yen to the dollar in 1991 to 78 yen to the dollar in 1994 to 143 yen to the dollar in 1998.

[tio]

19. A rabbit hole full of Japanese Bunnies!

Aww bunnies. Post bubble asia suffering from the hangover from the tryst with semi nationalist money (bad bunnies) had to think where next after the Washington spanking. Well the chrysanthemum throne ordered its central bank to issue free money aka ZIRPing itself, woo-hoo (waa?/hold on/be kind/rewind ... HAHAHA). This of course meant curtailing/fiddling the issuance of domestic credit but that was OK since its debts were domestic too and the dear old Dai-Nippon Teikoku Rikugun hasn't figured out that the Shogunate will export or die (well them anyway). Anyway this funny money quietly (shhh) flooded the planet and those tools (a) too stupid enough to permit it & (b) too blind with greed to 'just say no' (*giggle*) went nuts. This spawned the so-called 'yen carry trade' a euphemism for 'carrying' (transfering) free money from Nippon to any market that bore interest and then enjoying the 'spread' (difference in interest rates). Now you too can be a hedge fund, sell your soul and the rest is E.Z.! Now I'm going to short hand the rest. Japan gets uppity with China and waves fistfuls of funny money at them, China then kicks Japan in the wedding vegtables, Japan caves and so too does the carry trade, the bubblenomics (join the dots people!) of the US pops ... and ... well you know the rest. Hmm, the moral here is that money goes up and down like a bride's nightie for pretty much the same reasons.

[notesdev]

13. The error is in the assumptions

Our economy is not improving. At best, the rate of decline may have dropped slightly. This bear market rally is fueled by speculation as to who is going to get government money, but the reality is the government cannot raise anywhere near the amount of money to cover all the bad bets that were made. Banks who hold securities backed by no-doc loans, for example, cannot be made whole. Nor can the people who used a pay-option ARM to live well beyond their means.

The big picture of what is happening is that we are headed straight for a major bond market dislocation. What this means is real terms is that the US government may run out of the ability to borrow money at any reasonable rate. The government would immediately have to shrink to 60% or even less of its present size. An attempt to print our way out of it will only make things worse, adding high inflation to the mix, which in turn would require printing more money in a never-ending cycle (as in Zimbabwe and Weimar Germany).

Here's where those rising interest rates really hurt: there are still millions of people in exotic, underwater mortgages out there at 2002-2008 interest rates (the artificially low ones caused by the Federal Reserve under Greenspan and Bernanke). For the beginning of this year, interest rates were even lower than that time span, and there was the opportunity for some of those people to refinance at lower rates, to turn some of these defaults and potential defaults into functioning, regularly paid mortgages. These are the same types of mortgages that became 'reserve capital' through the credit default swaps with AIG.

So... back to the dollar vs. other currencies. The dollar is dropping on the expectation of future hyperinflation, which is basically the course that Congress and the Federal Reserve and the administration and decades of mounting obligations have put us on. People aren't too hot to have dollars anymore, since administrations and Congressmen from both parties, as well as the Federal Reserve, have been openly flouting established law and practice. Nobody knows what limits, if any, there will be to policy, and this is undermining the stability, and thus the value, of the US dollar.

[pscot]

15. Currency fluctuations have more moving parts

than a Ferrari V-12. If one pays some attention to government bonds and to oil and gold markets, they offer a window onto currency movements. But it's a rather dirty window, and what one sees through it is not always clear. Robert Skidelsky's biography of Keynes offers some insights, but at 3 plump volumes, it isn't exactly a beach read.