Cad (1 Viewer)

[Saintly Devil]

Does anyone know the reason why a CAD is generally seen to lead to a depreciation and why a CAS is generally seen to lead to an appreciation in the dollar?

Note: I know why an increase in the CAD or a reduction in the CAS leads to a depreciation and why a reduction in the CAD or an increase in the CAS leads to an appreciation, but why is a CAD by itself generally lead to a depreciation? (or does it at all?!)

 

[AGB]

hypothetical...would u wanna invest in a company that has to continuously borrow to stay alive???

 

[ellipsis]

There was a choice article in the SMH on Saturday about why the CAD isn't a bad thing.

Not speficially about your question, but you could check it out anyway. Was pretty good, and might give some hints.

 

[Saintly Devil]

Originally posted by AGB
hypothetical...would u wanna invest in a company that has to continuously borrow to stay alive???

So is the reason purely based upon investor confidence in the economy, and that because a CAD is generally seen as "bad" (although according to that article by ross gittins, right now, it's not bad at all) it generally leads to a depreciation?

 

[AGB]

Originally posted by Saintly Devil


So is the reason purely based upon investor confidence in the economy, and that because a CAD is generally seen as "bad" (although according to that article by ross gittins, right now, it's not bad at all) it generally leads to a depreciation?

well the way that i understood it was through capital inflow (which is partly determined investor confidence)....however there may be another reason....anybody have other ideas????

 

[timmii]

Originally posted by Saintly Devil
Does anyone know the reason why a CAD is generally seen to lead to a depreciation and why a CAS is generally seen to lead to an appreciation in the dollar?

Note: I know why an increase in the CAD or a reduction in the CAS leads to a depreciation and why a reduction in the CAD or an increase in the CAS leads to an appreciation, but why is a CAD by itself generally lead to a depreciation? (or does it at all?!)

The AUD is a floating currency - i.e demand = supply (zero sum). As a result the balance of payments balances to equal zero. Thus a cad must be balanced by a capital/fin account surplus of the same magnitude. This can be achieved by attracting more investment, OR since "value" is an arbitrary amount denoted by currecy value, a depreciation of the dollar in turn leads to a greater "value" of capital inflow.

e.g if the CAD was $A10million then $A10million investment must be attracted. If the AUD = US50c and only $5million is about to be invested, the dollar automatically adjusts so that it is worth US25c so that in effect $A10million is attracted. The inverse is of course true for a CAS.

Please note, don't ever explain it that way in an essay...it is incredibly simplified, since investment and expenditure is happening simultaneously and constantly as are currency movements. Its just a case of the dollar adjusting so as to maintain a BoP balance, since the factors recorded on the BoP are actually those that determine supply/demand of the dollar (import, exports, services, investment, debt/equite financing...)

 

[astron]

A simple reply is:

A CAD generally has Imports exceeding Exports.
Imports are a supply factor of the dollar, Exports are Demand.

Thus, M>X increases supply, which will expand demand, causing the equilbrium price to fall. Thus, we have a depreciating dollar.

The same is true in the opposite situation

CAS:
X>M therefore Demand is increased, Supply expands, and the dollar appreciates.

In more general terms. All current account debits are supply factors, and all current account credits are demand factors. You can work off that too.

In a CAD, debits>credits therefore supply increases, $ depreciates

In a CAS, credits>debits therefore demand increases, $ appreciates.

 

[Saintly Devil]

Originally posted by astron

In a CAD, debits>credits therefore supply increases, $ depreciates

In a CAS, credits>debits therefore demand increases, $ appreciates.

Hmm......that doesn't seem right.

If there's a CAD, there is also a corresponding KAS. As the balance of payments equals zero the CAD is equal to but offset by the KAS.

This means that even though a CAD means debits are greater than credits in the current account, it doesn't mean debits are greater than credits overall - since in the KAS, credits will be greater than debits to the same amount as debits will be greater than credits in the CAD.

So i think it has to do more with investor confidence in the economy. A perfect example is the current deficit - even though our CAD is huge - i think something around 6% of GDP, our dollar has risen significantly - because of reduced investor confidence in the US economy and increased investor confidence in the Australian economy.

 

[bobo123]

heres a simple explanation by just looking at the goods and services balance of the CAD

a BGS deficit -> depreciation because demand for $A(from exports) falls in comparison to the supply of $A(from imports)


the investor confidence thing is true and its well known (or at least my teacher says ) that exchange rates are reflecting less and less of economic fundamentals.

 

[astron]

Originally posted by Saintly Devil


Hmm......that doesn't seem right.

If there's a CAD, there is also a corresponding KAS. As the balance of payments equals zero the CAD is equal to but offset by the KAS.

This means that even though a CAD means debits are greater than credits in the current account, it doesn't mean debits are greater than credits overall - since in the KAS, credits will be greater than debits to the same amount as debits will be greater than credits in the CAD.

So i think it has to do more with investor confidence in the economy. A perfect example is the current deficit - even though our CAD is huge - i think something around 6% of GDP, our dollar has risen significantly - because of reduced investor confidence in the US economy and increased investor confidence in the Australian economy.

Lets have a look at this.
If we follow this logic, then the dollar could never move.

Remember, the CAD and the C&FAS are affected by the BALANCE of credits and debits. Whereas the dollar is affected by the credits and debits themselves.

Even your idea of investor confidence doesnt match what you've put forward. If investors lose confidence, K inflows will be lessened, but the movement in the CAD would offset this you say, which would lead to no movement in the dollar.
This way of think doesnt make sense.

Hope that helps.

 

[astron]

Lets take this further:

Why is it that the BOP always balances under a floating exchange and not a fixed exchange?

Under a fixed exchange, you could have a CAD larger than the C&FAS

In which case debits exceeded credits.

Therefore, in the market forces, debits + K outflows > credits + K inflows.

Thus, the BOP would not have balanced.

UNDER A FLOATING EXCHANGE, SUPPLY = DEMAND.
Therefore, since supply exceeds demand, there would be downward pressure on the exchange rate. The exchange rate depreciates.
In the process, credits + K inflows INCREASE in value, (as the overseas currencies can purchase more Aus$)
and debits and K outflows DECREASE in value. (as the Aus$ can purchase less overseas $)

Thus, the Increase in credits and K inflows will reduce the size of the CAD, and increase the C&FAS. Thus, the C&FAS will be equal to the CAD.

I've included all this to show WHY it is true that the excess of debits will increase the dollar. The simple reason will do in an essay.
But the investor confidence does raise the fact that it is the K inflows and outflows that influence most of the dollar. (You can apply that situation to the one above. Just switch the two around from the CAD to the C&FAS)
However, the wording of the syllabus wants it from the CAD's perspective. ie. why does the CAD cause a depreciating dollar.
Though investment and speculation is correct as the major influences on the dollar, that would really be the correct answer for why a C&FAS causes a depreciating dollar.

I know its pedantic, but I hope that helps.