Currency Markets Risk Suite

CURRENCY MARKETS RISK SUITE

DAILY UPDATE

The Global Currency Market is facing turbulent fluctuations on the aftermath of the US and UK Subprime Mortgage Market collapses. Although the Sterling outlook is gaining momentum due to the fact of artificial confidence restoration induced by the Tripartite Pack, the US Dollar is still suffering a credibility crisis despite the Federal Reserve Intervention. Deeper insights exhibit pattern of trajectory ambivalence both with wider Risk Spectra and Embedded Monetary Circulation Velocity within the US Economy at large.

On the Asian Currency Market, the Japanese Yen is still leading the way with strong prospects thanks to heightened injection of Foreign Direct Investment in the South East Asia region (see Merger & Acquisition Risk Outlook) yet at the same time showing signs of erratic economy sustainability on the international level.

The clear winner on the Currency Market Risk Suite remains the EURO with enviable outlook on the short-term induced notable trade-offs with traditionally detrimental manufacturing exports (with the notable exeption of Germany).

Needless to point out, more drama is still at large as far as the US Dollar is concerned. Full recovery is not anticipated until the end of the third quarter of the year 2007 with end of year festive period the opportunistic ingredient for market stimulation.

The Composite Index of the Global Currency Market Risk is critically positioned at Risk Magnitude 7 on Lyscale Riskgrade.

US Dollar - Risk Magnitude 12 on the Lyscale Risk Grading System

UK Pound Sterling - Risk Magnitude 8 on the Lyscale Risk Grading System

EUROZONE Euro - Risk Magnitude 3 on the Lyscale Risk Grading System

JAPANESE Yen - Risk Magnitude 5 on the Lyscale Risk Grading System

LYSCALE RISKGRADE CURRENCY MARKETS RISK SUITE [US DOLLAR, UK POUND STERLING, EUROZONE EURO, JAPAN YEN]
	US DOLLAR	UK POUND STERLING	EUROZONE EURO	JAPANESE YEN	CMRISK COMP
	USA	UK	EUROZONE	JAPAN	CMRISK COMPOSITE
1
2
3			RM3
4
5				RM5
6
7					RM7
8		RM8
9
10
11
12	RM12
13
14
15
16
17
18
19
20

US DOLLAR

The dollar (currency code USD) is the unit of currency of the United States. It is normally abbreviated as the dollar sign, $, or as USD or US$ to distinguish it from other dollar-denominated currencies and from others that use the $ symbol. The U.S. dollar is divided into 100 cents.

Adopted by the Congress of the Confederation of the United States on July 6, 1785, the U.S. dollar is the currency most used in international transactions. Several countries use the U.S. dollar as their official currency, and many others allow it to be used in a de facto capacity. In 1995, over US $380 billion were in circulation, two-thirds of which was outside the United States. By 2005, that figure had doubled to nearly $760 billion, with an estimated half to two-thirds being held overseas, representing an annual growth rate of about 7.6%. However, as of December 2006, the dollar was surpassed by the euro in terms of combined value of cash in circulation. The value of euro notes in circulation had risen to more than €610 billion, equivalent to US$802 billion at the exchange rates at the time.

The U.S. dollar uses the decimal system, consisting of 100 equal cents (symbol ¢). In another division, there are 1,000 mills or ten dimes to a dollar; additionally, the term eagle was used in the Coinage Act of 1792 for the denomination of ten dollars, and subsequently was used in naming gold coins. In the second half of the 19th century there were occasional discussions of creating a $50 gold coin, which was referred to as a "Half Union," thus implying a denomination of 1 Union = $100. However, only cents are in everyday use as divisions of the dollar; "dime" is used solely as the name of the coin with the value of 10¢, while "eagle" and "mill" are largely unknown to the general public, though mills are sometimes used in matters of tax levies and gasoline prices. When currently issued in circulating form, denominations equal to or less than a dollar are emitted as U.S. coins while denominations equal to or greater than a dollar are emitted as Federal Reserve notes (with the exception of gold, silver and platinum coins valued up to $100 as legal tender, but worth far more as bullion). (Both one-dollar coins and notes are produced today, although the note form is significantly more common.) In the past, paper money was occasionally issued in denominations less than a dollar (fractional currency) and gold coins were issued for circulation up to the value of 20 dollars.

U.S. coins are produced by the United States Mint. U.S. dollar banknotes are printed by the Bureau of Engraving and Printing, and, since 1914, have been issued by the Federal Reserve. The "large-sized notes" issued before 1928 measured 7.42 inches by 3.125 inches; small-sized notes, introduced that year, measure 6.14 inches by 2.61 inches.

Notes above the $100 denomination ceased being printed in 1946 and were officially withdrawn from circulation in 1969. These notes were used primarily either in inter-bank transactions or by organized crime; it was the latter usage that prompted President Richard Nixon to issue an executive order in 1969 halting their use. With the advent of electronic banking, they became less necessary. Notes in denominations of $500, $1,000, $5,000, $10,000, and $100,000 were all produced at one time; see large denomination bills in U.S. currency for details.

International use
Comparison of worldwide use of the U.S. dollar and the euroThe dollar is also used as the standard unit of currency in international markets for commodities such as gold and petroleum (the latter sometimes called petrocurrency). Even foreign companies with little direct presence in the United States, such as the European company Airbus, list and sell their products in dollars, although some argue this is attributed to the aerospace market being dominated by American companies.

At the present time, the U.S. dollar remains the world's foremost reserve currency, primarily held in $100 denominations. The majority of U.S. notes are actually held outside the United States, known as eurodollars (not to be confused with the euro) regardless of the location. Economist Paul Samuelson and others maintain that the overseas demand for dollars allows the United States to maintain persistent trade deficits without causing the value of the currency to depreciate and the flow of trade to readjust. Milton Friedman at his death believed this to be the case but, more recently, Paul Samuelson has said he now believes that at some stage in the future these pressures will precipitate a run on the U.S. dollar with serious global financial consequences.

Not long after the introduction of the euro (€; ISO 4217 code EUR) as a cash currency in 2002, the dollar began to depreciate steadily in value. After the euro started to rise in value in March 2002, the U.S. trade and budget deficits continued to increase. By Christmas 2004 the dollar had fallen to new lows against all major currencies, especially the euro. The euro rose above $1.36/€ (under €0.74/$) for the first time in late December 2004, in sharp contrast to its lows in early 2003 (€0.87/$). In the first quarter of 2004 the U.S. dollar, with the advantage of Federal Reserve's policy of raising rates, regained some standing against all major currencies, climbing from €0.78/$ to €0.84/$. However, this raise was more than lost in the second half of 2004, and the dollar stood at $0.74/€ at the end of 2004. Of the last five years since 2002, 2005 was the only year in which the dollar actually recovered against the euro. Although some analysts previewed the dollar dropping as far as $1.60 per euro (€0.63/$), it finished the year 2005 with an increase against the euro and Japanese Yen, climbing from €0.74/$ to €0.83/$. However in 2006, the dollar again fell back to €0.76/$ against the euro. A rate reduction by the Federal Reserve in September 2007 raised the euro's exchange rate significantly.

The dollar as the major international reserve currency
Main article: Reserve currency
The dollar is the most important international reserve currency, followed by the euro. The euro inherited this status from the German mark, and since its introduction, has increased its standing considerably, mostly at the expense of the dollar. Despite the dollar's recent losses to the euro, it is still by far the major international reserve currency, with an accumulation more than double that of the euro.

In August 2007, two scholars affiliated with the government of the People's Republic of China threatened to sell its substantial reserves in American dollars in response to pressure that they exercise fair trade. The Chinese government denied that selling dollar-denominated assets would be an official policy in the foreseeable future.

Former Federal Reserve Chairman Alan Greenspan said in September 2007 that the euro could replace the U.S. dollar as the world's primary reserve currency. It is "absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as an equally important reserve currency.

UK STERLING

The pound (symbol: £; ISO code: GBP), divided into 100 pence, is the official currency of the United Kingdom and the Crown dependencies.

The official full name pound sterling (plural: pounds sterling) is used mainly in formal contexts and also when it is necessary to distinguish the currency used within the United Kingdom from others that have the same name. The currency name — but not the names of its units — is sometimes abbreviated to just "sterling", particularly in the wholesale financial markets; so "payment accepted in sterling", but never "that costs five sterling". The abbreviations "ster." or "stg." are sometimes used. The term British pound is commonly used in less formal contexts, although it is not an official name of the currency. A common slang term is quid (plural quid).

The pound was originally the value of one pound Tower weight of sterling silver (hence "pound sterling"). The currency sign is the pound sign, originally ₤ with two cross-bars, then later more commonly £ with a single cross-bar. The pound sign derives from the black-letter "L", from the abbreviation LSD – librae, solidi, denarii – used for the pounds, shillings and pence of the original duodecimal currency system. Libra was the basic Roman unit of weight, which in turn derived from the Latin word for scales or balance. The ISO 4217 currency code is GBP (Great Britain pound). Occasionally the abbreviation UKP is seen, but this is incorrect. The Crown dependencies use their own (non-ISO) codes. Stocks are often traded in pence, so traders may refer to Pence sterling, GBX (sometimes GBp), when listing stock prices.

Following the adoption of the euro by several countries, sterling became (possibly)the world's oldest currency still in use, and it currently holds the third largest portion of global currency reserves after the US dollar and the euro. The pound sterling is the fourth most-traded currency in the foreign exchange market after the USD, the euro, and the Japanese yen.

Legal tender and regional issues
Laws of legal tender are uniquely complex in the UK: according to the Royal Mint, legal tender means "that a debtor cannot successfully be sued for non-payment if he pays into court in legal tender. It does not mean that any ordinary transaction has to take place in legal tender or only within the amount denominated by the legislation. Both parties are free to agree to accept any form of payment whether legal tender or otherwise according to their wishes. In order to comply with the very strict rules governing an actual legal tender it is necessary, for example, actually to offer the exact amount due because no change can be demanded".

In England and Wales, banknotes issued by the Bank of England are legal tender, meaning that they should be accepted in payment of a debt; they do not have to be accepted, but the debtor has a good defence in law against being sued for non-payment of that debt. In Scotland and Northern Ireland, no banknotes are legal tender, and each bank which issues banknotes does so in the form of its own promissory notes. In the Channel Islands and Isle of Man the local variations on the banknotes are legal tender in their respective jurisdiction.

Scottish, Northern Irish, Channel Islands and Manx notes are sometimes rejected by shops when used in England. British shopkeepers can choose to reject any payment, even if it would be legal tender in that jurisdiction, because no debt exists when the offer of payment is made at the same time as the offer of goods or services. When settling a restaurant bill after consuming the meal, or other debt the laws of legal tender do apply, but usually any reasonable method of settling the debt (such as credit card or cheque) will be accepted.

Notes are issued by the Big Four banks in Northern Ireland — the Bank of Ireland, the First Trust Bank, the Northern Bank and the Ulster Bank. Notes printed by the Bank of Ireland, although in pounds sterling, are mistaken in England for the former Irish pound and often rejected[citation needed]. The only polymer banknote in circulation in the United Kingdom was issued by the Northern Bank. This is the bank's Year 2000 commemorative £5 banknote, which was printed in Australia.

Scottish bank notes are issued by The Bank of Scotland, The Royal Bank of Scotland and The Clydesdale Bank, but (as in Northern Ireland) are not legal tender. Only Royal Mint coins are legal tender in Scotland, and only one and two pound coins are legal tender to an indefinite amount. This was not always the case, as during World War II the Scottish banknotes were made legal tender by the Currency (Defence) Act 1939; this status was withdrawn on January 1, 1946. Some notes of the Bank of England were legal tender in Scotland and Northern Ireland; however, this status only applied to notes under a value of five pounds, so following the withdrawal of the Bank of England one pound note in 1985, no circulating notes are covered by this clause.

The UK one pound coin also has many varied designs on the reverse side, which differ from year to year with new designs appearing; however, all of these are Royal Mint coins and of equivalent legality. The Channel Islands (including Alderney) and the Isle of Man issue their own coinage.

All commonly circulating British coins are legal tender throughout the UK, in most cases up to a maximum value per transaction, as are the commemorative five pound and twenty-five pence ("crown") coins that are rarely seen in circulation. Several gold coins issued by the Mint are still legal tender, though as they have a bullion value far greater than their face value, they are never used in circulation and tend to be kept by collectors.

EURO

Euro (currency sign: €; banking code: EUR) is the name of the official currency of the Eurozone (also known as the Euro Area or the Euro Land), which consists of 13 European states (Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Slovenia, and Spain) and will extend to include Cyprus and Malta from 1 January 2008. It is the single currency for more than 320 million Europeans. Including areas using currencies pegged to the euro, the euro directly affects more than 480 million people worldwide. With more than €610 billion in circulation as of December 2006 (equivalent to US$802 billion at the exchange rates at the time), the euro is the currency with the highest combined value of cash in circulation in the world, having surpassed the U.S. dollar.

The euro was introduced to world financial markets as an accounting currency in 1999 and launched as physical coins and banknotes in 2002. It replaced the former European Currency Unit (ECU) at a ratio of 1:1.

The euro is managed and administered by the Frankfurt-based European Central Bank (ECB) and the European System of Central Banks (ESCB) (composed of the central banks of its member states). As an independent central bank, the ECB has sole authority to set monetary policy. The ESCB participates in the printing, minting and distribution of notes and coins in all member states, and the operation of the Eurozone payment systems.

While all European Union (EU) member states are eligible to join if they comply with certain monetary requirements, not all EU members have chosen to adopt the currency. All nations that have joined the EU since the 1993 implementation of the Maastricht Treaty have pledged to adopt the euro in due course. Maastricht obliged current members to join the euro; however, the United Kingdom and Denmark negotiated exemptions from that requirement for themselves. Sweden turned down the euro in a 2003 referendum, and has circumvented the requirement to join the euro area by not meeting the membership criteria.

On the other hand, several small European states (The Vatican, Monaco, and San Marino), although not EU members, have adopted the euro due to currency unions with member states. Andorra, Montenegro, and Kosovo have adopted the euro unilaterally, while not being EU members as well.

Transaction costs and risks
The most obvious benefit of adopting a single currency is removing from trade the cost of exchanging currency, theoretically allowing businesses and individuals to consummate previously unprofitable trades. On the consumer side, banks in the Eurozone must charge the same for intra-member cross-border transactions as purely domestic transactions for electronic payments (e.g. credit cards, debit cards and cash machine withdrawals).

The absence of distinct currencies also removes exchange rate risks. The risk of unanticipated exchange rate movement has always added an additional risk or uncertainty for companies or individuals looking to invest or trade outside their own currency zones. Companies that hedge against this risk will no longer need to shoulder this additional cost. The reduction in risk is particularly important for countries whose currencies have traditionally fluctuated a great deal, particularly the Mediterranean nations.

Financial markets on the continent are expected to be far more liquid and flexible than they were in the past. The reduction in cross-border transaction costs will allow larger banking firms to provide a wider array of banking services that can compete across and beyond the Eurozone.

Price parity
Another effect of the common European currency is that differences in prices—in particular in price levels—should decrease because of the 'law of one price'. Differences in prices can trigger arbitrage, i.e. speculative trade in a commodity between countries purely to exploit the price differential, which will tend to equalise prices across the euro area. Similarly, price transparency across borders should help consumers find lower cost goods or services. In reality, the effects of the euro over the level of the prices in Europe are disputable. Many citizens cite the strong perceived increase in prices in the years after the introduction of the euro, although numerous empirical studies have failed to find much real evidence of this. [1] It is speculated that the reason for this perception is that the prices of small, everyday items were rounded up significantly. For example, a cup of coffee that once cost two German Mark might now cost €1.50 or even €2.00—a 50–100% increase, although wages in many countries have also increased. At the same time, a large appliance or rent payment rounded up to the next obvious euro level would be a negligible proportional increase. The fact that the prices people see every day were affected more strongly might explain why so many people perceive the "euro effect" as being significant, while official studies—which look at the breadth of expenditures, in proportion—would downplay it.

Macroeconomic stability
Low levels of inflation are the hallmark of stable and modern economies. Because a high level of inflation acts as a highly regressive tax (seigniorage) and theoretically discourages investment, it is generally viewed as undesirable. In spite of the downside, many countries have been unable or unwilling to deal with serious inflationary pressures. Some countries have successfully contained them by establishing largely independent central banks. One such bank was the Bundesbank in Germany; as the European Central Bank is modelled on the Bundesbank, it is independent of the pressures of national governments and has a mandate to keep inflationary pressures low. Member countries join the bank to credibly commit to lower inflation, hoping to enjoy the macroeconomic stability associated with low levels of expected inflation. The ECB (unlike the Federal Reserve in the United States of America) does not have a second objective to sustain growth and employment.

National and corporate bonds denominated in euro are significantly more liquid and have lower interest rates than was historically the case when denominated in legacy currencies[citation needed]. While increased liquidity may lower the nominal interest rate on the bond, denominating the bond in a currency with low levels of inflation arguably plays a much larger role. A credible commitment to low levels of inflation and a stable debt reduces the risk that the value of the debt will be eroded by higher levels of inflation or default in the future, allowing debt to be issued at a lower nominal interest rate.

A new reserve currency
The euro is widely perceived to be a major global reserve currency, sharing that status with the U.S. dollar (USD), albeit to a lesser degree. The U.S. dollar continues to enjoy its status as the primary reserve of most commercial and central banks worldwide.

Since its introduction, the euro has been the second most widely-held international reserve currency after the U.S. dollar. The euro inherited this status from the German mark, and since its introduction, has increased its standing somewhat, mostly at the expense of the dollar. The possibility for the euro to become the first international reserve currency in the near future is now widely debated among economists.[2]PDF (297 KiB) Former Federal Reserve Chairman Alan Greenspan gave his opinion in September 2007 by stating that the euro could indeed replace the U.S. dollar as the world's primary reserve currency. He said that it is "absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as an equally important reserve currency.

Additionally, there has been some suggestion that the recent weakness of the US dollar might encourage various parties to increase their reserves in euro at the expense of the dollar.

International role of the euro
While at the end of last year the value of dollar bank notes in circulation was surpassed by that of euro bank notes, the value of dollars circulating outside the U.S. was about four to six times as great as the value of euro bank notes outside the euro zone.

Additionally, the euro's role in foreign-exchange markets has been slipping. Its share in daily security settlements fell to about 39% during 2006 from about 41% previously. At the same time, the dollar share was broadly stable at 92.5%, confirming that currency's dominant role. (The sum of the currency percentage shares is 200 percentage points as both currencies involved in the settlement of a foreign-exchange trade are counted individually.)

In the United Kingdom, although not a member of the Eurozone, many high-street banks report that as much as 90% of their international trade is conducted in euro. It is common therefore for them to use the euro as their 'core' currency on international business systems, only converting to Sterling for local accountancy purposes.

JAPAN YEN

The yen (円, en?) or en is the currency of Japan. It is also widely used as a reserve currency after the United States dollar, the euro and the pound sterling. The ISO 4217 codes for the yen are JPY and 392. The Latinised symbol is ¥ while in Japanese it is also written with the kanji 円. While not a usage specific to currency, large quantities of yen are often counted in multiples of 10,000 (man, 万) in the same way as values in the United States are often quoted or rounded off to hundreds or thousands.

The yen was introduced by the Meiji government in 1870 as a system resembling those in Europe. The yen replaced the complex monetary system of the Edo period, based on the mon. The New Currency Act of 1871 stipulated the adoption of the decimal accounting system of yen (1, 圓), sen (1⁄100, 錢), and rin (1⁄1000, 厘), with the coins being round and cast as in the West. The yen was legally defined as 0.78 troy ounces (24.26 g) of pure silver, or 1.5 grams of pure gold. The same amount of silver is worth about 1181 modern yen,[2] while the same amount of gold is worth about 3572 yen. The Act also moved Japan onto the gold standard. (The sen and the rin were eventually taken out of circulation at the end of 1953.)

Fixed value of the yen to the US dollar
The yen lost most of its value during and after World War II. After a period of instability, in 1949, the value of the yen was fixed at ¥360 per US$1 through a United States plan, which was part of the Bretton Woods System, to stabilize prices in the Japanese economy. That exchange rate was maintained until 1971, when the United States abandoned the gold standard, which had been a key element of the Bretton Woods System, and imposed a 10 percent surcharge on imports, setting in motion changes that eventually led to floating exchange rates in 1973.

An undervalued yen
By 1971 the yen had become undervalued. Japanese exports were costing too little in international markets, and imports from abroad were costing the Japanese too much. This undervaluation was reflected in the current account balance, which had risen from the deficits of the early 1960s to a then-large surplus of U.S. $5.8 billion in 1971. The belief that the yen, and several other major currencies, were undervalued motivated the United States' actions in 1971.

The yen and major currencies float
Following the United States' measures to devalue the dollar in the summer of 1971, the Japanese government agreed to a new, fixed exchange rate as part of the Smithsonian Agreement, signed at the end of the year. This agreement set the exchange rate at ¥308 per US$1. However, the new fixed rates of the Smithsonian Agreement were difficult to maintain in the face of supply and demand pressures in the foreign-exchange market. In early 1973, the rates were abandoned, and the major nations of the world allowed their currencies to float.

Japanese government intervention in the currency market
In the 1970s, Japanese government and business people were very concerned that a rise in the value of the yen would hurt export growth by making Japanese products less competitive and would damage the industrial base. The government therefore continued to intervene heavily in foreign-exchange marketing (buying or selling dollars), even after the 1973 decision to allow the yen to float.

Despite intervention, market pressures caused the yen to continue climbing in value, peaking temporarily at an average of ¥271 per US$1 in 1973 before the impact of the 1973 oil crisis was felt. The increased costs of imported oil caused the yen to depreciate to a range of ¥290 to ¥300 between 1974 and 1976. The re-emergence of trade surpluses drove the yen back up to ¥211 in 1978. This currency strengthening was again reversed by the second oil shock in 1979, with the yen dropping to ¥227 by 1980.

The yen in the early 1980s
During the first half of the 1980s, the yen failed to rise in value even though current account surpluses returned and grew quickly. From ¥221 in 1981, the average value of the yen actually dropped to ¥239 in 1985. The rise in the current account surplus generated stronger demand for yen in foreign-exchange markets, but this trade-related demand for yen was offset by other factors. A wide differential in interest rates, with United States interest rates much higher than those in Japan, and the continuing moves to deregulate the international flow of capital, led to a large net outflow of capital from Japan. This capital flow increased the supply of yen in foreign-exchange markets, as Japanese investors changed their yen for other currencies (mainly dollars) to invest overseas. This kept the yen weak relative to the dollar and fostered the rapid rise in the Japanese trade surplus that took place in the 1980s.

The effect of the Plaza Accord
In 1985 a dramatic change began. Finance officials from major nations signed an agreement (the Plaza Accord) affirming that the dollar was overvalued (and, therefore, the yen undervalued). This agreement, and shifting supply and demand pressures in the markets, led to a rapid rise in the value of the yen. From its average of ¥239 per US$1 in 1985, the yen rose to a peak of ¥128 in 1988, virtually doubling its value relative to the dollar. After declining somewhat in 1989 and 1990, it reached a new high of ¥123 to US$1 in December 1992. In April 1995, the yen hit a peak of under 80 yen per dollar, temporarily making Japan's economy nearly the size of the US.

Post-bubble years
The yen declined during the Japanese asset price bubble and continued to do so afterwards, reaching a low of ¥134 to US$1 in February 2002. The Bank of Japan's policy of zero interest rates has discouraged yen investments, with the carry trade of investors borrowing yen and investing in better-paying currencies further pushing down the yen estimated to be as large as $1 trillion.[5] In February 2007, The Economist estimated that the yen is 15% undervalued against the dollar and as much as 40% undervalued against the euro.

MAJOR CURRENCY COMPOSITE RGS

Penetrate the Global Economy with Scientific Precision