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 What is a dollar anyway?

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gastaoss



Number of posts : 440
Registration date : 2007-07-01

PostSubject: What is a dollar anyway?   Thu Sep 13, 2007 10:11 pm

Minyanville's five things you need to know to stay ahead of the pack on Wall Street:
Despite reaching levels that are technically oversold during the
month of June, the greenback just can't catch a break. What's going
on? What is a dollar? Why do we care whether it goes up or down in
value? Isn't the dollar I'm holding today the same as it was
yesterday? Why can't the Fed just print more dollars?

1. What is a dollar anyway? What does it mean?


  • The dollar is simply a banknote issued by the U.S.
    government that is mandated by law to be used as legal tender for all
    transactions.
  • Although the dollar used to be backed by
    gold, today it is backed simply by the promise of the government that
    it will be convertible in an exchange.
  • Got faith?
    Good, you'll need it, because faith is the only thing standing between
    a dollar bill as exchangeable for say, a banana, and just a blank sheet
    of paper.


2. OK, OK, I got faith aplenty, so where do all our dollars come from, and why can't the Fed just print more money?


  • The Fed can print money.
  • And the missing M3 money supply data (which the Fed abruptly stopped publishing this spring) suggests they do. A lot.
  • But every dollar created dilutes the value of a dollar already in circulation, causing it to weaken.
  • Of
    course, we don't notice this dilution immediately unless we travel
    outside the country, and if everything we consumed was produced here in
    America we probably wouldn't notice a weak dollar at all! Yippee!
  • Wait, did you see the trade report this morning? The trade report is what we import (buy) compared to what we export (sell).
  • D'oh! We ran a trade deficit of $62 billion dollars.


3. OK, so, we're spending more than we're making, and
the Fed is printing money to make up the difference. How does the Fed
do it?


  • The Fed "prints" money through three mechanisms. The
    easiest way is through the Fed's Open Market Operations. Through open
    market operations, the Fed buys and sells, literally, Treasuries that
    are trading in the "open market." If the Fed buys Treasuries, then the
    dollars it uses to buy them become available to banks to lend. If it
    sells Treasuries, the dollars get taken back.
  • The
    second mechanism is lowering the percent of deposits banks are required
    to have on hand - thereby increasing the pool of available money to
    lend.
  • The third is through their "discount policy."
    The discount rate is the interest rate charged to commercial banks and
    other depository institutions on loans they receive from their regional
    Federal Reserve Bank's lending facility. The Fed can grow money by
    reducing the discount rate.
  • Dollars are literally printed by the Bureau of Engraving and Printing.


4. Trade deficit, weaker dollar... I kinda get it. The
Fed has to print more money. But the more money they print, the weaker
the dollar gets. Who is paying for all of this and what's the
connection with foreign central banks?


  • Because Americans as a whole spend more than they save,
    both individually and collectively as a government, that money has to
    come from somewhere.
  • Since the more money the Fed
    creates, the weaker the dollar gets, how do we get all these dollars to
    spend without collapsing the currency?
  • One way is through the purchases by central banks of countries like China and Japan.
  • We have to "sell" our Treasury bonds to countries willing to buy our debt, paying them interest for financing our spending.
  • Foreign
    governments all over the world also use the dollar as a foreign
    exchange reserve, allowing them to control their own currency,
    increasing or decreasing it compared to other currencies, and to
    maintain stability of their currency in the event of an economic shock.
  • Because the dollar is perceived as the most stable currency in the world (note: key word is perceived) countries are willing to finance our spending by purchasing dollars and bonds.
  • But,
    if they begin to perceive they are not being adequately compensated for
    the risk of holding our debt, or if their dollars are depreciating
    faster than they like, these countries will demand a higher interest
    rate to buy our bonds. So, a weak dollar can lead to higher interest
    rates! That affects you, Mr. or Ms. Homeowner-Credit Card Spender-Business Professional-Student!


5. Ok, so bottom line is this for me: In the simplest
terms, what are the advantages or disadvantages of a stronger or weaker
dollar?


  • Weak dollar - Advantages
    - Easier for U.S. companies to export goods because foreign currencies can buy "more" against the weaker dollar.
    - Tourism increases because foreign visitors find it less expensive to visit.
    -
    To an extent, foreigners will view investment opportunities here more
    favorably since they can buy more for their yuan/yen/euro/pound, etc.
  • Weak dollar - Disadvantages
    -
    Higher prices for consumers. (We don't notice this because the Chinese
    yuan is tied to the dollar in a tight range and most of our imports
    come from China - just look at your shirt and your shoes!)
    - Higher interest rates, i.e. higher cost of money to consumers.
    - More expensive to travel abroad.
  • Strong dollar - Advantages
    - Lower prices for imported goods.
    - U.S. investors can buy foreign assets and investments at lower prices.
  • Strong dollar - Disadvantages
    - Harder for U.S. companies to compete abroad.
    - More expensive for foreigners to visit U.S.

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