THE EXCHANGE RATE...

[kingconquerer]

FOR THOSE WHO HAVE BEEN KEEPING UP, HAVE YOU NOTICED THE LOWER EXCHANGE RATE LATELY? NOW, I'M NO ECONOMICS MAJOR BUT I SUSPECT THAT PRESIDENT LULA IS HAVING A POSITIVE IMPACT ON THE ECONOMY. IS THAT TRUE? WHAT KIND OF EFFECT HAS HE HAD SO FAR?

[fernandobn]

Me either, but my experience says do not get too excited about that. Our economy minister says that our exchange gonna find it's balance point in the market. The goverment have two goals: reduce the relation debt/PIB and inflation control. Good news for people who depend on money from Brazil and bad news for people who send money there.

[expatriate]

When I moved here to Rio, the exchange rate was near 4 to 1. I think that was at least in part because people (here and elsewhere) were worried about what Lula would do. Now it is about 3 to 1. Other than Lula not being the "radical" disaster that some feared, I'm not sure what has really changed about the Brasilian economy to cause the rise of the real. Admittedly 3 to 1 is much closer to the exchange rate prior to the elections and may be more realistic.

What I have not personally seen happening yet, and what at least in theory should happen with a cheaper U.S. $, is a reduction in the price of imported goods. My Brasilian wife chuckles at the idea that that will happen. The other side of that coin is that exports become more expensive. Not good if your economic growth depends in large part on exporting.

While I personally miss the 3.5+/- to 1 exchange rate, I think that market forces will ultimately decide just where the the real should trade. And if it is 3 to 1, so be it. I've learned to live a much simple lifestyle here in Rio than in the U.S.

[um observador]

The Federal Banks of the USA are doing everything they can to prevent deflation (believed to be the greatest current risk to the US economy). As a result the US is printing money like crazy, and lowering interest rates to levels not seen in 40 years. Resulting in the redcution in value of the Daller relative to the Real.

If the deflationary threat is beaten, and the US economy improves, the US Federal banks will start trying to prevent inflation by tightening the money supply and increasing interest rates. The result will be an increase in value of the Dollar relative to the Real

[MAttER]

That would be a good explanation except...
The real has strengthened compared to almost every currency, including the euro.

It is not so much a weaker dollar, which is just part of it, but a truly stronger real.

[um observador]

Certainly, what you say is true! Neither currency is fixed. Both fluctuate. And certainly, the economy of one country effects the economy of the other.

Be careful, if the Brazilian economy has problems, the problems are felt around the world. However, the US economy is too big. When the US economy has problems, economies around the world start thrashing.

Unless something drastic happens in either country, and assuming Lula does a good job over the near future, the relative value of the Real to the Dollar over the next couple of years will depend on how the US economy handles inflation/deflation pressures. The US economy is too big.

I can't predict the future, however, I suspect the US inflation/defalation beast will be tamed for a few years. In which case the US economy will improve. Over the near frutre, the Dollar will become stronger relative to the Real, Brazilian exports will increase, pulling more money/investments into Brazil. And the Brazilian economy will improve.

that is my best guess for the near term future.

But, economics is the "dismal" science.

[MarriedtoABrasileira]

To an Observer

Your are right about the threat of deflation in the US. The US and Europe both have relatively low interest rates. While Brazil can pay you 15% a year on your savings. Therefore, rational people will keep their reais parked in Brazil and global investors will buy Brazilian government bonds (at least for the short term). The spread is so big that it compensates for the inherent risk of the Brazilian currency. Therefore, when the interest rates starts to get closer, the exchange rate will change in the dollars and Euro's favor again.

But of course I could be wrong!!

[MarriedtoABrasileira]

More on Exchange rate

Sorry to be so long winded, but I was thinking, this would be a good place to ask people, what do you think the risk premium is for the real?

In other words, what interest rate spread would you deem necessary in order to take the risk to deposit some of you money into a Brazilian bank?

On a personal note, my wife would rather make 2% in the US than 15-18% in Brazil, I don't agree, but I haven't lived through all of the changes in currency that she has.

Thanks for your time!

[um observador]

More on Exchange rate

Sorry to be so long winded, but I was thinking, this would be a good place to ask people, what do you think the risk premium is for the real?

In other words, what interest rate spread would you deem necessary in order to take the risk to deposit some of you money into a Brazilian bank?

On a personal note, my wife would rather make 2% in the US than 15-18% in Brazil, I don't agree, but I haven't lived through all of the changes in currency that she has.

Thanks for your time!

hmmmm, complicated stuff.......
18 % return on your investment in the Real is pretty good. It is the equivalent to having a dollar if the dollar increased in value from 3.00 Rais to 3.54 Rais.

So, the question you have to ask yourself is "where will the Real be relative to the dollar in 1 year?".

It is almost like rolling the dice.

My semi-educated best guess is that the dollar will be stronger than it is now. But, ironically, I am not willing to bet money on it. I do not have to, the dollar is the safer bet.

Bush is doing everything he can to kick start the business sector (deficit spending, tax cuts, etc.... ) into spending money.

But, even if Bush fails, there is an old adage in American slang you have to think about. It goes something like this. "Never bet against the Fed", meaning the federal banks. The US Fed (Greanspan et. al.) is doing everything in its power to prevent deflation (by printing money, lowering interest rates, etc ....). If the Fed is not successful, expect the dollar to fall continuously, as the Fed continues to print money, etc .... . If the Fed is successful expect the dollar to turn around within a few months.

Your brasilada sounds like she has good instincts. My guts tell me to follow her advice on this. When in doubt regarding money you already have and will need for the future, I suggest you follow a conservative path. But possibly take some portion you can afford to loose and gamble with it.

But, what do I know? I assure you I do not know much. I am not an economist. I am not a financial advisor.

Also , If I could predict the future, I would have been rich a long time ago.

[Brazuca]

Hey, isn't Tim into all this stuff? I barely understand a word y'all are saying. All I know is that they should ban the Fed and go back to a fully backed gold standard (or something that can't be printed and is difficult to get), thereby stopping the boom-bust cycle and inflation.

[MarriedtoABrasileira]

To an observer

I'm not a financial advisor or an economist and I have definitely missed my quota of investments, so I appreciate your comments and I am swayed by your arguements. The risk of a complete currency meltdown of the real is just too great.

Lula seems to be doing well right now, but from what I hear in Brazil, is that the economy is worse than ours and people are having a hard time finding work (not that they always did), therefore the pressure to inflate and deficit spending will grow as new elections come closer.

It will be interesting to see what happens in the coming year.

Thanks

[um observador]

MarriedtoABrasileira:
I am happy to help, but please take everything I said on this subject with a grain of salt! I know next to nothing, which is more than many, but less than some others.


Brazuca:
you are asking someone to explain one of the intangibles of life. I advize you not to trust anyone who claims to fully understand it (even if Greanspan tells you he fully understands it, don't trust him). Managing an economy is art, not mechanical engineering. The art is managed by mechanical things, as a paint brush is used to mechanically distribute paint on a canvas, but in essence the painting it is art. And, as discussed on other threads on this forum, this art is related to culture/ideology/worldview/religion.

Like other intangibles, it is not fully understood, yet many know more than I know. Maybe someone will post.

A couple of points, and I will come close to exhausting my knowledge on the subject:

(1) the boom bust cycle existed long before 1971, when the dollar was removed from the gold standard.

(2) if wealth is created out of nothing (and it is), wealth cannot be based on a fixed quantity of anything (not even gold)!

[Brazuca]

(2) if wealth is created out of nothing (and it is), wealth cannot be based on a fixed quantity of anything (not even gold)!

You're right. What I should have said is that the government should get their dirty hands off such matters and leave things to find their own, natural price. Value is not inherent but imputed -- which is why a fixed standard would be wrong. My mistake. It's still early days for me yet in learning about and understanding economics.

[Zí©]

Ignorance really doesn't bother you, does it?

[Brazuca]

No, I know that I'm not omniscient and that I need learning. But a festering inferiority complex would certainly bother me.

[um observador]

.... What I should have said is that the government should get their dirty hands off such matters and leave things to find their own, natural price. .....

Brazuca, my friend:
I finaly found somthing where I strongly disagree with you. this is a first!!

The money supply is one area where the government has tremendous responsibilities. The money supply is a basic part of the infrastructure of an economy, as are roads, a court system for interpreting contracts, a police department for protecting the peace, etc ....

The boom/bust cycle has always existed in economic markets. Human psychology plays a major roll in this. You might find it fascinating to study the price of tulips in Holland during the later half of the 18’th century.

With modern economies, a government has a few obvious levers to push/pull in order to reduce the extremes of the boom/bust cycle.

An overly simplified explaination goes like this:

If the economy is getting over heated, it will drastically over produce, at which point there will be a collapse, as business cannot sell that which they have in their warehouses. To prevent the economy from overheating, the government attempts to make it more difficult for a business to borrow money (by raising interest rates). A government also does this by raising taxes, which are then put to good use, but usually in a very inefficient way, further pulling money out of the economy.

If the economy is spiraling downward, a government will attempt to encourage business to invest by lowering interest rates and cutting business taxes. A government will also cut personal taxes in order to encourage people to buy things to heat up the economy. This is what has been happening for the past couple of years in the USA. The economy slipped into recession during the last couple of months of the Clinton administration. Bush and Greanspan have been focused on getting the economy out of recession using the above techniques.

As an economy does this, it effects the exchange rate with other world currencies. However, this is usually a secondary effect. It is usually not the primary intent (This is true, usually for the largest economy in the world, the USA).

[MarriedtoABrasileira]

to an observer

You wrote:
If the economy is getting over heated, it will drastically over produce, at which point there will be a collapse, as business cannot sell that which they have in their warehouses. To prevent the economy from overheating, the government attempts to make it more difficult for a business to borrow money (by raising interest rates). A government also does this by raising taxes, which are then put to good use, but usually in a very inefficient way, further pulling money out of the economy.

------

I would word the above paragraph slightly differently.

If the economy is experiencing price inflation, which doesn't necessarily mean over producing, but more likely over demanding. Too much demand going after too few goods, which pushes prices up. The Fed dampens demand by raising the cost of money (interest rates).

Now the earlier statement (not by you) that the government should adhere to a gold standard and get out of the market. does have merit. But could we ever go back? with the flow of currency, derivatives, etc. I wonder what would happen? The price of gold is holding relatively stable against the dollar. Plus, your point is that there would be much less power by the Fed to smooth out the boom bust periods.

[um observador]

If the economy is experiencing price inflation, which doesn't necessarily mean over producing, but more likely over demanding. Too much demand going after too few goods, which pushes prices up. The Fed dampens demand by raising the cost of money (interest rates).

Certainly what I posted did not tell the whole story, I was trying to keep things very very simple for readers with no experience. Even the details I include below, are only an effort to scratch the surface.

Regarding your addition ".... too much demand going after too few goods....". You are not wrong. However, in my opinion, high prices is not the problem.

Regarding manufactured goods, manufacturers will not gear up to produces anything unless there is pent up demand that is not yet satisfied. The problem is not high prices (again, I am talking about manufactured goods). Demand for products encourage manufacturers (due to high potential profits) to gear up to satisfy the demand. However, if it happens to quickly, there will be a switch from:

an under-supplied marketplace (boom times for the economy, as everyone is able to find work to gear up to satisfy the demand and workers pay serves to increase the demand, etc .... spiral upward, inflation)

to

an over-supplied marketplace (bust times for the economy, as business cannot make money by selling their products, there is no need for workers to manufacture the products. Since workers are unemployed they have no money further decreasing demand, forcing business to decreace prices, etc .... spiral downward, deflation)

The switch results from production outpacing demand. There are many reasons for this. Some of them simple, some complex, most of it psychological. All the reasons blend together making the problem nearly unfathomable.

Since the 1930's, in the USA (I do not know about the rest of the world), The US government and the Federal Banks have attempted to throttle back on the boom (making money harder to get) in an effort to fend off the bust. When bust does occur, they pump money into the system as a way of encouraging everyone to spend, increase demand and manufacture goods, higher employees, etc .....

Now the earlier statement (not by you) that the government should adhere to a gold standard and get out of the market. does have merit. But could we ever go back? with the flow of currency, derivatives, etc. I wonder what would happen? The price of gold is holding relatively stable against the dollar. Plus, your point is that there would be much less power by the Fed to smooth out the boom bust periods.

Any type of a fixed standard would be a mistake.

There are many forms of wealth. Most wealth is not mined out of the ground. Most wealth is created out of nothing by people! The society is economicaly wealthy when the overwhelming majority of persons are reasonably active, have their basic physical needs met, and are optimistic about the future. The gold standard is a standard that is unrelated to real economic wealth.

That is my opinion, anyway.

[Brazuca]

an observer, here's a link to a short book which is a summary by Dr North of Ludwig von Mises' economic philosophy. I haven't actually read this book but have read North's books and he uses Mises for much of his inspiration. Since this one's quite short, I figure it's better than linking you to another one of North's longer books. It basically goes agains your views and finds in government interference the problems in our economies. I've found North's thesis cogent.

http://www.lewrockwell.com/north/mom2.html

[um observador]

an observer, here's a link to a short book which is a summary by Dr North of Ludwig von Mises' economic philosophy. I haven't actually read this book but have read North's books and he uses Mises for much of his inspiration. Since this one's quite short, I figure it's better than linking you to another one of North's longer books. It basically goes agains your views and finds in government interference the problems in our economies. I've found North's thesis cogent.

http://www.lewrockwell.com/north/mom2.html

Brazuca:
I will give it a read.
cheers