Overview, Knowing the US Dollar, How To Read US Economy

World Currencies are influenced by a number of factors. It would be highly beneficial to realize the significance of the general economic characteristics of the currencies being traded, and they way they influence the currency fluctuations.

Overview of the US Economy

With a GDP of nearly US$12Trl (2005), the US Economy is the biggest in the world, leaving behind the likes of UK, Japan & Germany. The US assets are known for their Investor Confidence, which is primarily due to its high liquid equity & fixed income market. FDI (Foreign Direct Investments) in the US are to the tune of 41% of net global inflows. Not surprisingly, hence, nearly 73% of the net savings from foreign countries are parked in the US. Needless to say, the US assets & the USD would be severely impacted if the return on investment is not attractive enough for the foreign investors and they park their funds elsewhere.

One also needs to know the influence of International Trade on the US Dollar. It is interesting to note that the US has a trade deficit of about US$550bln, notwithstanding the fact that business with US accounts for about 21% of the entire International trade. Such a large trade deficit indicates that Goods & Services exported out of the US fall short of the Imports into the US by a very huge margin!! This clearly puts pressure on the Dollar to prevent its devaluation by facilitating & maintaining a huge, steady inflow of foreign money into the US by way of investments. This works out to be a handsome US$2 trillion per day!! Mind-boggling. Isn't it? Indeed, statistics show that the Dollar has been able to successfully woo foreigners into investing money into US - the global net inflow into the US has doubled within a short span of 5 years - from 1995 to 2001.

The US carries out most of its Trade with Canada, European Union, Mexico, Japan & UK (both Exports & Imports). All these countries are important trading partners for the US. Trade with US also constitutes the major part of Imports & Exports for other countries like Australia, China, New Zealand, Switzerland & Germany.

An important point to be noted here is the robustness of the US Economy. The service sector has dominated the US Economy with a lion's share of about 81%. And, it is the amazing speed with which they have adapted the latest technologies, that has made the US less and less vulnerable to economic depressions.

The Federal Reserve Board (Fed)

They are the Architects & Controllers of the US Economic Policies. They form the central bank of the US, and are the final decision makers. The Fed continuously monitors the state of the US Economy and takes measures to ensure that Inflation & Unemployment remain under control. Basically, the Fed keeps the long-term objectives of the US Economy in its mind, and are immune from any political interference. Achieving economic growth is fine; but the growth has to be self-sustaining to have its long-term influence felt. The Fed makes mid term and short term corrections in its monetary policies to achieve these objectives. The Fed team is made up of a 12-member committee called the Federal Open Market Committee (FOMC). Out of the 12, seven are governors of the Federal Reserve Board, while five are presidents of the twelve district reserve banks. Any statements from the Fed make headlines; their fixed annual activities include eight meetings and issuance of 'Monetary Policy Report' twice a year - in February and July. The forecasts for Economic growth, Unemployment and Inflation from the FOMC are contained in this report; and the Federal Reserve Chairman is answerable to the Banking Committee and the Congress through the Humphrey Hawkins Testimony after the release of the Monetary Policy reports.

There are a wide variety of ways in which the Fed controls or 'steers' the US Economy. Some of these are discussed below.

The Bank Rate (or the 'Fed Funds Target')

This is one of the tools most frequently used by the Federal Reserve to control the US Economy. Basically this rate controls the flow of money in the economy - the extent to which the banks in the US can borrow money and lend. Inflation is characterized by increased flow and availability of money in the economy -disproportionate to the goods and services produced in the economy, while deflation implies otherwise. The Fed raises the Bank rate to slow down the movement of money thereby tending to reduce inflation. Along the same lines of logic, it reduces the same rate to encourage lending and borrowing, to consequently stir up the economy if it is headed towards a state of deflation. It is of greater interest to note that any change in the US Bank rate influences the global equity markets in a big way. As it can be inferred from the previous analysis (Overview of the US Economy), the US Fed Reserve favours a strong US Dollar to ensure a strong and steady inflow of funds into the US.

Operations in the Open Market

What constitutes Government Securities? Notably, Bonds, Notes & Treasury Bills. One needs to understand that the interest rates tend to increase or decrease respectively with the availability or scarcity of government securities in the open market. The Fed uses this principle to control the interest rates - they sell the securities to push up the interest rates, or buy them to bring the interest rates down.

Overview, Knowing the US Dollar, How To Read US Economy