Lessons fundamental analysis 6

In a previous publication, we began to analyze the relationship of balance of payments data and the dynamics of the U.S. dollar over the past 30 years. In general, we concluded that the theoretical calculations are confirmed by history. However, in 2001-2003, had an interesting situation - interest rates fell, accompanied by a fall in the dollar and the increase in the negative trade balance. It is time to deal with this phenomenon. Just to say that a clear interpretation of this phenomenon, I have not met, therefore, set out his vision.

Is it true that increased the negative balance of trade?
If you simply look at the figures, then, of course, yes. But let's take a look at the situation from a different position. Over the past decades, the role of international trade in the economies of almost all countries without exception increased, of course, the U.S. had not been an exception. Let us take a table of data from previous publications, and a bit of change. We do not need data on the current account, and data on imports is more convenient to take with the sign "+".

Balance of Payments Analysis (millions of USD)

Tab. 1. Analysis of trends in foreign trade in the U.S. in the last 30 years

And now, according to data from the table to build a schedule, causing its exports, imports and trade balance as a percentage of GDP. For more visibility to impose on the resulting curves trendline.

Fig.1. Trends in foreign trade in the U.S.

Obviously, the role of foreign trade in the U.S. economy all these years has increased. This steady trend observed excess of imports over exports, the overall proportional growth of foreign trade. In 2001-2003, the same increase in the negative balance of trade accuracy for speed in line with long-term trend. Thus, by consideration of the positions can be assumed that in 2001-2003 the value of a negative balance of trade was relatively stable!

Interest rate differential
To date, we have always said that the value of net foreign investment is determined by the value of real interest rates. Here it is necessary to make an important clarification. The value of net foreign investment does not depend on the interest rate only within the country, and the ratio (margin) interest rates at home and abroad. This difference is often called interest differential. In general, the correlation remains unchanged: the increase in the differential of net foreign investment will decrease, and vice versa.

Expectations of changes in interest rates
In recent years, the market (FOREX) is indeed very different. This includes, inter alia, to increase the impact on the dynamics of exchange rate expectations of participants. The growing importance of the statements made by officials in the hope of finding in them that would enable to assess the future direction of economic policy, including with respect to interest rates.

Let's go back to the situation before us.

Major market participants have sufficient and reliable information, it can expect a consistent reduction in rates in the U.S. and take appropriate action. Since our model consists of a basic component and does not take into account the speculative factor, then remove from consideration large speculators, and will continue to believe that the relatively long term, exchange rates are set by the interaction of supply and demand, which are determined by net exports and net foreign investments, respectively.

So, the exporters and importers expect a steady decline in U.S. rates. They are also well aware that such a reduction would lead to a drop in the dollar, and exports from the U.S. will become more attractive as compared to imports. What steps they will take in this situation? Of course, the importers will take steps to conserve (protect) its future income, and exporters - to increase their future profits. This may be the display of the changes in the timing of supply, timing and manner of payment, increasing the hedge, etc. But the result will be one - at constant prices and exchange rates should go off in the direction of the current increase in imports and reduce exports.

And now look at the schedule.

Fig.2. Influence of expectations to changes in interest rates on the exchange rate

Thus, the curve of net exports is moving in the direction of reduction, that is left. As we already know from previous publications, the shift of the curve of net exports leads to a change in the national currency, but does not appear on the balance of trade. In this case, the dollar is declining.

Let's go back to the rates. Governments of major U.S. trading partners were concerned about the likely future decline in rates, because it should lead to a decrease in the dollar and improve the U.S. trade balance (and consequently to a deterioration in the balance of their trading partners). To try to prevent such a development could be this way - affecting the U.S. proposal at the currency exchange market (ie the value of net foreign investment dollars). A large proportion of official foreign assets in the U.S. in the total amount of assets owned by non-residents in the U.S., serves as proof of that.

The simplest and clearest example of how the government's main trading partners of the United States (this especially applies in the East-Asian states) affect the value of net foreign investment in the U.S. are the Bank of Japan currency intervention. The result of such interventions will shift the curve of net foreign investment in the reduction, ie, the left (see picture), and, at least so far as to offset the impact of lower interest rates on the value of U.S. net exports (to prevent deterioration of their balance of trade).
As a result, have a depreciation of the dollar at about the same or even slightly deteriorating state of the U.S. trade balance.
From a consideration of the situation can be inferred - the analysis of the dynamics of exchange rates should take into account the expectations of market participants, since in recent times this factor becomes increasingly important.

Andrew Khamidullin
to Forex Magazine
fxtrade@tomsk.ru