An importer wants to short the dollar …

Tywin Lannister decides to invest in the import/export business.  He wants to import certain goods from the United Kingdom and resell them in the United States.  He estimates that he will need 7.5 million British pounds (GBP) to purchase, package, process, and deliver his British goods to the U.S. 

At an exchange rate of $1.3740 per British pound, he estimates borrowing $10.305 million from his US bank.  The borrowed amount also includes his estimated profit.

To sweeten the deal with the prime brokerage division of his bank, he offers up $1.05 million dollars in cash and securities as collateral.

Lannister’s business venture so far in Great Britain is a success.  His take comes in (for the purpose of this discussion) at the estimated 7.5 million GBP which also includes his profit.  He would not mind expanding his profit so he hopes that the dollar weakens or depreciates. Fortunately for Lannister the dollar price of a pound has increased to $1.5801.  After converting his pounds to dollars, he realizes $11.85 million, and after repaying his loan, he takes home approximately $1.54 million in profit from his venture.

Lannister likely benefited from a number of market forces.  For example, incomes in the US may have been increasing faster than those in the UK thus increasing demand for the UK’s exports and currency.  The UK’s currency appreciates versus the US.

Prices in the US may have been rising rapidly when compared to prices in the UK. The resulting demand for lower priced UK products would have resulted in an appreciation of the UK’s products and currency.

In addition, interest rates in the UK may have risen higher than in the US, incentivizing the movement of money from the US to the UK resulting in an appreciated UK currency.

A trader’s sound monetary policy strategy will emphasize interest rate moves, but will not discount to zero the other market forces that impact currency values.  Lannister no doubt kept his eyes on all the factors, but given that a central bank is the “farmer” of its nation’s respective currency, Lannister, and any other importer, will pay close attention to the interest rate actions (monetary policy) of its central bank.

Alton Drew 23 September 2021

Interbank Market News Scan: The fallacy of free markets

1 September 2021

It is in the best interest of governments and their central bank underwriters that government maintains some control over the market price for currencies.  As a reflection of the underlying value of a political economy, currency prices signal a country’s capacity to entertain investment.  Stable currency prices transmit a message that the underlying economy operates in an environment of legal, social, and regulatory certainty.  Whereas financial markets enjoy the profits and arbitrage opportunities that volatility may bring, governments and their central bank underwriters prefer a law-and-order environment for trade.  Certainty of domestic and foreign investment along with tax and customs collection is the higher priority for government.

There is a lot of noise that, in my opinion, blocks out these basic tenets of political economy.  It is no wonder that chartists or technical analysts focus primarily on pip movements on their bar graphs.  Pontification on future government moves can cause hair to be pulled out and put a trader into a state of mental numbness.  The trader cannot, however, take her eyes off of the policy ball for it is the policy maker, in this case the Federal Reserve, that provides the nutrients for currency growth and circulation.  It is their narrative that drives prices.  It is their decisions on reserve requirements, asset purchases, and fed fund and discount window rates that signal to their currency vendors, the banks, the varying rates that currency is sold to the public.

And thus, this is part of the fallacy; that banks are somehow free market players charging a market-driven interest rate for loans.  On the contrary.  Banks are more like government chartered (commissioned) privateers who sell currency to the public either via loans or directly over the counter during foreign exchange transactions.  Banks are merely doing the bidding of a government that needs its currency to flow to activities that eventually generate taxable events.  Banks provide government with a low-cost information search alternative for seeking out and financing high-yielding taxable events.

The trader should maintain focus on policy narratives and decisions that will impact the price of the dollar, currently the world’s most prevalent reserve currency.  Central banks are consuming economic, political, and these days more social data and inputting this information into their narrative.  The narrative creates the marching orders for their chief currency vendors, the banks.  There is no free market when your marching orders come from the central bank.  The free market is a fallacy that serves only to create a lot of noise from amongst the chattering classes.

Alton Drew

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