The recent fall in the value of the Australian Dollar, while painful for Australians looking to travel overseas, has proven popular with many traders whose trading accounts are denominated in US Dollars.

From a traveller’s perspective, every cent that the Australian Dollar falls means less spending money in their pockets when they convert their Australian Dollars into US Dollars.

However, the sharp falls have eased the pain of those traders watching their US Dollar accounts erode in value with the strengthening Australian Dollar.

Imagine you were a trader who wanted to trade options on the US market. You open an account with a US Broker in 2002 and send over $A10,000 to fund your account. With an exchange rate of 0.5000, you now have $US5,000 in your account.

Now imagine you are a conservative trader and over those 6 years you managed to double your trading account. Your trading account is now $US10,000.

Now you decide to bring the money back to Australia. However, it’s 2008, and the exchange rate is now 0.9800 (98 cents). Suddenly, you need 98 US cents just to buy 1 Australian Dollar, whereas six years ago, you only needed 50 US cents.

Now your $US10,000 – which was double your initial investment - is only worth $A10,204. Nearly all of your gains have been wiped out by the exchange rate fluctuations. Can you see the importance of managing your currency risk?

Chart 1 below shows the weekly bar chart of the Australian Dollar (FXADUS in ProfitSource)

Chart 1

click to enlarge

As you can see, it is not just Currency Traders who are faced with the risks associated with changes in the exchange rate. Of course, had the trader waited until October to bring their US Dollars back to Australia, the exchange rate would have been much more favourable for them.

Anyone with any exposure to overseas currencies, whether through their trading, their travel plans, or business transactions needs to manage their currency risk.

So how can we go about it?

The simplest way to lock in the exchange rate today is to open an FX trading account. Let’s say we have some US Dollars sitting in a bank account in the United States.

If the Australian Dollar rises in value, the US Dollars will fall in value, meaning less Australian Dollars should we decide to bring the money to Australia. To lock in the current exchange rate, we can open an FX hedge by opening a currency position.

In any FX transaction, we are always buying one currency, and selling a second currency.

So in this case we would open a position that would buy Australian Dollars, and sell enough US Dollars to cover the money in our US bank account.

As long as there is enough money in your FX trading account to cover the margin on the trade, you will be able to leave this hedge open until you are ready to bring your US Dollars back to Australia. If Australian interest rates are higher than US interest rates, you can even be paid interest on your position, in what is called a “carry trade”.

If you have US Dollar exposure and you don’t check the exchange rates very often, it can be a good idea to hedge your position and lock in your exchange rate, to remove the possibilities of any nasty surprises.

There are other methods for locking in an exchange rate using Forward Exchange Contracts and options, however that is a subject for another article.

There are some very nervous bankers and others in the financial world awaiting the approval of the $US700 billion bailout from the US Congress and Government.

Amid uncertainty about the plan’s prospects, US cash funds and banks stampeded to safety, buying short-term government debt, selling commercial paper and withdrawing funds from the interbank market. As a result, the rates that banks charge each other soared, while yields on short-term Treasury bills plunged.

Now it seems the plan is headed for approval with: it has to be signed off by the rest of the two parties’ representatives, US Treasury and other regulators.

Republicans are refusing to agree to the scope and direction of the legislation and this could defeat it as Democrats say they won’t pass it without substantial Republican support.

President Bush held a meeting with Barack Obama and John McCain and others at the White House.

The legislation will go to the US House of Representatives tonight, our time, and the US Senate will meet on Saturday to debate and approve it.

But it needs consensus, and if that’s not apparent, then trading will be fraught tonight.

Wall Street kicked higher in anticipation; up 300 points at one stage, then down sharply, before rising at the end to be up nearly 200 points on the Dow. It closed before signs of a lack of agreement emerged in Washington.

Financial stocks rose 2.6% and were among the biggest gainers on hopes that the plan would unlock frozen money markets.

GE rose 4.4% even after the world’s fourth-largest company cut its third-quarter and full-year earnings forecast and suspended a share buy-back. It was GE’s the second earnings downgrade this year.

Escaping the bullish momentum, Washington Mutual, America’s biggest savings and loan plunged 25% to just $US1.69 on reports that regulators were struggling to broker the takeover of the company.

Oil rose, the US dollar was stronger (and the Aussie was back around 83.60 US cents) and gold weakened. US Treasury bond yields rose on the news.

Figures were released showing another sharp slump in new US home sales and industrial production. It was a reminder that the real problems remain and won’t be touched by the bailout plan.

Stockmarkets in Asia fell, especially in Japan and Australia, thought China’s were higher. 

Stocks in Europe were up in early trading and finished higher, with gains in the UK, France and London as news spread of the broad agreement on the bailout.

Money market rates in Asia’s biggest financial centres jumped on concern that the US Congress might hold up or water down the Treasury Department’s plan to bail out the financial system (or at least try to).

A cash freeze has gripped world financial markets as fearful banks hoard billions and billions of dollars and prefer to leave it on deposit with central banks and earn less than they could get from lending it to normal business and personal customers.

Not even Australia is exempt: our well capitalised banks were following suit and sitting on billions of dollars.

Banks around the world are refusing to deal with each other, or anyone else, so they are leaving tens of billions of dollars on deposit with central banks.

The drought has worsened significantly since the collapse of Lehman Brothers 10 days ago and still rising losses taken by bond holders and other investors.

Bank nervousness seems to have picked up from earlier this week as the progress of the US bailout proposal slows in the Congress.

If that proposal was to fail, markets would dry up and if there was to be a reason why the global economies slumps into recession or worse, it would be this cash drought. The money’s there, tucked away in cash management accounts and at central banks, but no one is willing to lend. There is no shortage of borrowers.

Central banks in the UK and Australia moved this week to try and ease the drought by moving to mop up the cash.

The drought has seen short term interest rates around the world rise sharply as banks choose to leave their money with the central bank, or invest in short term US Government treasury notes as the ultimate short-term safe haven.

Short term US treasury note rates have again fallen under 1% while short term US dollar (and some other currency) LIBOR rates in London has jumped sharply to levels seen in the dark days of early January.

The three-month US Treasury bill traded at 0.49% in New York overnight, down from 0.79% at the close Tuesday and 0.88% on Monday.

The demand for short term, security can be seen from the results of a huge US Treasury auction of $US34 billion in two-year bonds: demand was about normal for the moment at 2.2 times the amount offered. Market yields for the notes traded down to 2.02%,

In Australia yields on 90 day bank kills, the key short term funding source in the country, have risen to where they are higher currently than 180 day bills. It is normally the other way around. Spikes like we are seeing are signs of a cash shortage.

A cash freeze has gripped world financial markets as fearful banks hoard billions and billions of dollars and prefer to leave it on deposit with central banks and earn less than they could get from lending it to normal business and personal customers.

Not even Australia is exempt: our well capitalised banks are following suit

Banks around the world are refusing to deal with each other, or anyone else, so they are leaving tens of billions of dollars on deposit with central banks around the world.

The drought has worsened significantly since the collapse of Lehman Brothers 10 days ago and still rising losses taken by bond holders and other investors.

Bank nervousness seems to have picked up from earlier this week as the progress of the US bailout proposal slows in the Congress.

If that proposal was to fail, markets would dry up and if there was to be a reason why the global economies slumps into recession or worse, it would be this cash drought. The money’s there, tucked away in cash management accounts and at central banks, but no one is willing to lend. There is no shortage of borrowers.

Central banks in the UK and Australia have moved within the past 24 hours to try and ease the drought by moving to mop up the cash.

The drought has seen short term interest rates around the world rise sharply as banks choose to leave their money with the central bank, or invest in short term US Government treasury notes as the ultimate short-term safe haven.

Short term US treasury note rates again fell under 1% while short term US dollar (and some other currency) LIBOR rates in London has jumped sharply to levels seen in the dark days of early January.

The three-month US Treasury bill traded at 0.49% in New York overnight, down from 0.79% at the close Tuesday and 0.88% on Monday.

The demand for short term, security can be seen from the results of a huge US Treasury auction of $US34 billion in two-year bonds: demand was about normal for the moment at 2.2 times the amount offered. Market yields for the notes traded down to 2.02%,

In Australia yields on 90 day bank kills, the key short term funding source in the country, have risen to where they are higher currently than 180 day bills. It is normally the other way around. Spikes like we are seeing are signs of a cash shortage.

Three-month interbank offered rates in Hong Kong and Singapore have risen sharply as well (Hong Kong has just had a run on the Bank of East Asia on Wednesday, which frightened the market there).

Dealers said the three month rates (90 days) jumped past the levels when Lehman Brothers filed for bankruptcy and the U.S. government nationalized American International Group last week.

Three-month rates on yen loans rose to a two-month high and bill swap rates in Australia soared to the highest since August.

In China however, shares rose to a three-week high yesterday as parent companies continued to buy back shares of their listed subsidiaries after the central government made that move easier as a way of helping stop the market slump.

In Australia, banks kept $6.9 billion in their exchange settlement accounts instead of using it to lend to one another. That was the highest amount kept in the ESA at the Reserve Bank since the credit crunch started and it’s a sign the banks are fearful of liquidity risk, even with one another.

Japan’s trade account dropped into a surprise deficit in August as high oil prices pushed up import costs, but more importantly, exports slowed to a trickle.

Apart from January, which usually sees low levels of exports because of factory closures, it was the first monthly deficit since 1982, when Japan was reeling from the aftermath of the second oil crisis.

But, more important was the bad news from the export account.

Shipments to the United States had their sharpest fall ever from the same month a year earlier.

Exports rose 0.3% in August from August 2007, compared to a forecast of a rise of 2.4%.

Japan’s exports to the United States fell a record 21.8% last month, marking the 12th straight month of annual declines, on sluggish shipments of automobiles and consumer electronics.

Exports to the European Union fell for the third month in four.

A 6.7% rise in shipments to Asia and an 8.8% rise in exports to Japan’s new number one destination, China (for the second month in a row), couldn’t offset the slump in exports to the US and Europe.

Japan’s economy contracted in the second quarter at its sharpest rate in seven years thanks to slowing demand from the US and Europe and there are growing fears that it will shrink this quarter to put the country into a proper recession.

And major car companies, Toyota and Honda chopped back car production and exports in Japan and in the US and Europe in response to the slow down. Toyota’s global output was cut by a substantial 17%.

The Reserve Bank has moved to try and solve a shortage of US dollars in the Asian area by joining a swap arrangement involving the US Federal Reserve.

The shortgage of US dollars outside the US has continued despite moves by the Fed to inject more into the global economy.

The RBA has joined central banks from Norway, Sweden and Denmark in setting up a US dollar swap arrangement with the Fed totalling $US30 billion and lasting until at least the end of January 2009.

The RBA said currency swap lines have been set up between itself, the Fed and the Denmark, Norway and Sweden central banks - Danmarks Nationalbank, Norges Bank and Sveriges Riksbank.

“The swap serves to alleviate a shortage of US dollar liquidity which has affected market participants around the world including in the Asia-Pacific time zone,” the RBA said.

That’s part of a global shortage which saw short term rates in Europe for US dollar loans soar overnight to their highest levels since January.

At the same time, rates on US Government three month T-notes again fell sharply as banks and othert investors chased security while the $US700 billion bailout plan was being debated in Washington. 

The rates are not as low as they were a week ago when markets frayedf, but they are heading that way, indicating a sharp contraction in the availability of US dollars.

Hence the series of US dollar swaps the Fed has conducted in the past week with central banks around the world.

The US dollars will be made available, against collateral, to local market participants by the RBA through an auction, the first of which will happen tomorrow.

The term of the initial swap will be 28 days.

Subsequent auctions will depend on market conditions.

The RBA did a $1 billion US dollar swap last Thursday to try and pump extra American dollars into the market to accommodate demand from fund managers and others looking for greenbacks for end of quarter transactions.

“These facilities, like those already in place with other central banks, are designed to improve liquidity conditions in global financial markets,” the RBA said in a statement that was released simultaneously with a similar notice from the Fed.

“Central banks continue to work together during this period of market stress and are prepared to take further steps as the need arises.”

The Fed said in its statement that the swap lines it will have with the RBA, Denmark Norway and Sweden central banks are a $US30 billion addition to the $US247 billion previously authorised temporary swap arrangements with other central banks announce earlier this month.

“In sum, these new facilities represent a $30 billion addition to the $247 billion previously authorized temporary reciprocal currency arrangements with other central banks: European Central Bank ($110 billion), Bank of Japan ($60 billion), Bank of England ($40 billion), Swiss National Bank ($27 billion), and Bank of Canada ($10 billion),” the Fed said in its announcement.

In a separate announcement the RBA said that it will establish a domestic term deposit facility to further enhance the flexibility of domestic liquidity management operations.

“To further enhance the flexibility of its domestic liquidity management operations, the Reserve Bank will offer a short-term deposit facility (to be known as RBA Term Deposits),” it said.

The facility will be available to institutions holding an exchange settlement account and to authorised deposit-taking institutions.

The RBA will conduct auctions at which eligible institutions will be able to bid for deposits.

The first of auction, for a deposit of 14 days, will be held next Monday, September 29.

It will be run in addition to the current system of injecting funds each morning via repurchase deals involving government bonds and other securities as well as asset backed commercial paper and residential backed mortgages.

The offer to take short-term deposits from banks and financial institutions is going to be aimed at mopping up liquidity from banks, as part of its domestic operations.

Analysts said the bank is trying to attract some of the excess overnight funds that banks are holding as they refrain from lending to each other at the moment because of the credit crunch.

That has led to a spike in term-money rates, especially in three month bill rates. They are above the rates for 180 day paper: 7.43% versus 7.34%. This has been happening since the start of the month

The RBA yesterday $815 million in repurchase agreements, compared to an estimated cash deficit of $612 million. It drained a small amount on Tuesday, but resumed pumping in extra cash on yesterday as interbank lending rates remained high.

The FX markets have been more than choppy these past 2 months. The surge of the US Dollar across the board is still valid with the global retracement of commodities and tangible asset prices.

Yesterday was a particular day as the decision made by the US government to fully finance and support Fannie Mae and Freddie Mac has been a bullish decision for the equity markets that soared impressively worldwide.

At the same time, the currencies attempted to bounce back the same way against the Greenback, which generated a gap at the open (which is rare on the FX markets). You can see this gap on the chart (in the blue ellipse). Last Friday the AUD/USD closed at 0.8163 when it opened yesterday morning at 0.8321!!

Click to Enlarge

However the daily trend changed radically when PPI data was released more dovish than expected in the UK. As a result, traders bought back the US Dollar massively. The AUD/USD eventually closed at 0.8155 yesterday (it’s not a real close as the FX market is running 24 hours a day but it’s the close of the Australian trading time zone). What does this mean? Well, it means obviously that the market is really nervous, therefore potentially highly volatile.

Big moves during the next weeks are then expected. Many economic data and statistics are to be published in the US this coming Friday. It should give a better idea of the future price action. Indeed, traders and investors don’t trust the Dollar, but they don’t believe too in either the Euro or the Sterling. The AUD remains a local currency and is too linked with commodities prices.

That’s why, before any potential data that could be bearish for the US Dollar, the current bullish trend, started at mid-July, should continue. The bullish trend occurred between August 2007 and July 2008 (between points A and B) has retraced for a large part and it does not appear to be over. The last support, which was the 61.8% Fibonacci ratio, around 0.85 (point C), was cleared in early September and therefore has opened the way to a complete correction towards the low of August 2007.

The near-term resistance is the 15-day moving average to the price action failed to breakout above recently. The momentum and oscillator indicators remain bearish. Since the beginning of August, the RSI has been moving in the oversold area. However, the RSI did not succeed to escape this oversold area (points D and E) so the signal is still bearish. The MACD confirms that the trend is going downward.

The current bearish trend does not have any major support level before the low of August 2007. This point is likely to be therefore the target of the current price action. $0.7934 was the lowest closing price while $0.7672 had been the lowest intraday price. It may be the range where buying interests will give some potential rebound for the Aussie.

This is pretty typical of professional traders. All the pros leave the FX market alone on holidays. In fact, my opinion is that the Forex market should post a sign that says “Enter at your own risk” during major U.S. holidays.

I say this because the Forex market is like a renegade switch on most holidays. The market is either “turned on” and your trades are moving like crazy (which means it’s hard to predict what will happen next). Or the market is completely “turned off,” and it’s about as interesting as watching paint dry.

More often than not, you’ll see BOTH scenarios happen on a single holiday. First the market will be switched on, and then it will suddenly switch off - or vice versa. Unfortunately, there’s never any telling which comes first…the “calm” or the “storm.”

So on any given holiday, I generally wait until the afternoon to check on the currency markets. Then I just wait for the “show” to start. Frankly, for a seasoned trader like myself, it’s fun to watch the markets move that fast.

But it’s definitely NOT time to start trading. Please keep that in mind for every holiday going forward.

As I said yesterday, Vanuatu is a group of 80 islands in the South Pacific Ocean, about three-quarters of the way between Hawaii and Australia.

And most recently, this small tropic paradise is gaining a new reputation as a “tax haven.” But does this island chain deserve that title?

we review the laws, political stability, economic climate, available legal entities, the tax situation, financial privacy rules, and the overall financial reputation of a jurisdiction. (Our top favorites remain Switzerland, Panama, Liechtenstein, and Hong Kong.)

For almost 40 years, Vanuatu certainly has been known to some as a tax haven. That explains why so many accountants, bankers, and lawyers are clustered in this small island nation.

But the archipelago’s reputation as an offshore financial center has been highly questionable, to say the least.

In 2000, the Asia-Pacific Group on Money-Laundering claimed the Russian mafia was laundering billions of dollars through offshore banking systems in the Pacific, including Vanuatu. There are about 2,000 registered institutions offering a wide range of offshore banking, investment, legal, accounting, and insurance and trust company services. Vanuatu also maintains an international shipping register in New York City.

In an unprecedented action in December 1999, a group of leading international bankers, pressured by the U.S., placed a ban on U.S. dollar denominated transactions involving three Pacific island nations - Nauru, Palau, and Vanuatu. The bankers accused them of laundering money for the Russian mafia and the South American drug cartels. At the time Vanuatu had 63 licensed offshore banks.

These bankers put a banking ban on these three countries because they were concerned about a report issued by the OECD’s Financial Action Task Force. The report called Vanuatu a “jurisdiction of prime concern” for money laundering because of these same mafia and drug cartel concerns.

Perhaps this small country is eager to distance itself from this past history, because the Vanuatu Government now welcomes outside investment to help develop their country.

The lack of income tax, capital gains tax, death and estate tax is an obvious attraction for outside investors. Plus, the country has no exchange controls. In 2002, following increasing international concern over money laundering, Vanuatu increased oversight and reporting requirements for its offshore sector.

But it was not until 2008 that Vanuatu agreed to release account information to other governments or law enforcement agencies. International pressure, mainly from Australian tax collectors, influenced the Vanuatu government to move to increased transparency.

Tax police raids in Australia this year have spurred a debate on whether Vanuatu will remain a tax-free haven.

Bottom line: We don’t recommended Vanuatu as an appropriate offshore financial haven, because of the history and other reasons stated above. But we also steer clear of this haven because it has a less developed offshore professional sector than other havens. Also, the government is not stable at all.

We wish the Vanuatu islanders well, and we remain open to change our current opinion. But in the meantime, there are too many other well-established offshore financial centers to choose from that deserve more serious consideration.

The US Dollar ended the week with a sharp rally that confirmed the recent breakout and the base building that began following the March 2008 low of 70.70, analysis at the time suggested that the Dollar was heavily oversold and projected a target towards $78, which is now in reach following the USD Index close of 77.15 on Friday.

Last weeks continuing rally is taking the US Dollar into a short-term overbought state, especially as it nears resistance at 78, on break of which the US Dollar will target a move towards significant resistance at 80, following which the Dollar is expected to consolidate, with the previous resistance levels turning into support levels i.e. Major support at 74.30 and 78, before the next leg up through resistance above 80 takes place towards a longer-term target for the dollar of 90.

Whether or not the Dollar has seen its final low that brings to an end the 7 year long bear market, what the recent price action does signal is that the US Dollar is now in a bull market that looks set to run for at least a year, by which time the longer term trend will become more apparent, in that respect the bullish dollar trend is expected to continue into at least early 2009, which confirms analysis as early as of March 2008 that concluded that the commodities markets would enter into a bear market during the summer of 2008 that would last for at least 1 year and possibly as long as 2 years.

The US Dollar Index (USDX) is an index that measures the value of the US Dollar relative to a basket of foreign currencies (EUR, JPY, GBP, CAD, SEK and CHF).

In 2008, the Index has hit its historical low levels as the US Dollar has been hammered while oil, gold and commodities prices were soaring. Analysts and investors still consider that the negative correlation between the greenback and commodities is valid.

Fundamentally, the global economic outlook has not changed since the correction started around mid-July. Therefore it makes sense to admit that the current price actions on both currencies and commodities markets are based on charts and technical analysis.

The US Dollar went too low too fast according to the market, especially while the Euro-zone struggles with weak growth and high inflation. Market players also consider that the fundamentals do not justify the recent rising prices on energy tangible assets; that Asian demand may slow, and that speculators have driven the price up too high.

As a result, the charts recently illustrated this with obvious oversold levels on the US Dollar. From the high posted in July 2001 (at 124.365 points) to the recent historical lows (posted last April and last July), the US Dollar Index has lost more than 42% of its value.

Where the current correction could lead the Index?

Let’s have a look at a daily medium-term chart. Broadly speaking, the Dollar Index has been declining since July 2001, as mentioned above. Only one significant countertrend occurred during this 7-year period, it is when the Index bounced back during the year 2005. A consolidation phase followed during the 9 first months of 2006, and then a new bearish trend started, backed by the global commodities boom.

The historical low has been posted on April 22 this year, at 71.455 (point B on the chart). The Index rebounded slightly and then slid back to this low level on July 15 (point C on the chart) before rebounding sharply. It’s a double-bottom pattern which constitutes a solid support basis for the price action.

Consequently the Index has been climbing by roughly 8% over the past month. It is now at 77.35. However a pull back is more than likely soon. Indeed, this sharp rebound is not sustainable at the current pace. A trend is always the succession of different waves and of corrective moves.

Two elements argue for a short-term pull back. First the oscillators show obvious overbought levels. The 14-day RSI has jumped above 85, which has not occurred since 1997. Second, there are two intermediary resistance levels that should convince investors to sell back the US Dollar.

The current level is indeed the 38.2% Fibonacci retracement ratio of the last bearish trend occurred between October 2006 and April 2008 (between point A and point B).

A further move up would lead the Index towards other resistance levels. 78.5 is the level of a significant previous low posted on the last day of 2004 (point D). As previous lows often become new highs, there is there some potential US Dollar sellers ready to take advantage of a pull back.

In this scenario, the Index may fall back to 75, where there should have some intermediary support. It would be a healthy correction and a new basis for a further bullish momentum.

Blame It On Oil and Germany

What’s causing the latest drop in gold prices? You can blame it on the resurgent U.S. dollar, falling crude oil prices, and the latest batch of economic data in Germany. The latest data coming out of the biggest Eurozone economy points to a contraction of second quarter gross domestic product (GDP). This data was critical because it compelled foreign exchange traders around the globe to shift their focus and dump the euro last week.

A big drop in crude oil prices is another major factor lending support to rising stock values since mid-July. As inflationary pressures continue to ease, the market has begun to discount the possibility of a quick economic recovery in the United States later this year.

Lower commodity prices act like a tax cut for consumers. These lower prices reduce the coast of living and allow consumers to spend more disposable income to non-energy and food items.    

The dollar, of course, had been heavily oversold for months. Since peaking just north of 1.60 euro, the greenback has rallied an impressive 6.5% since early July.

In Europe, economic growth is now slowing sharply following the release of second quarter German GDP, which showed a contraction. Along with other stumbling economies in the Eurozone, the European Central Bank (ECB) is unlikely to keep raising interest rates this year - especially if oil prices continue to decline.

That makes U.S. dollar assets more attractive for prospective investors because Europe is behind the United States in the economic and credit cycle.

The most important part of investing is to clearly understand what you’re investing in. In the currency world, most currency traders will talk about the “seven” majors.

The seven majors are the currencies that are traded most often on major brokerage desks around the world. The seven majors are generally paired with the dollar, so technically, the U.S. dollar would count as the eighth “major.”
Here’s a quick 30 second introduction to each of the major currencies…

U.S. Dollar (USD): The majority of trades in the Forex market involve the U.S. dollar against a different currency because it is currently used as the world’s reserve currency.

Euro (EUR): This is the new kid of the currency majors. Lately, the euro has been stepping up to take its place as a reference currency, as well as a larger component of foreign reserves by banks. It is also known as the anti-dollar because the euro tends to appreciate as the dollar depreciates.

Japanese Yen (JPY): The yen has been known as the carry-trade currency because for years, investors have borrowed yen to fund their carry-trades. Because Japan imports all of its oil, when crude oil prices begin to climb this hurts its economy and greatly impacts the value of the yen.

Swiss Franc (CHF): Also known as Swissie, it is sometimes called a ‘safe heaven,’ due to Switzerland’s independent stance, economy isolation, and strong private banking system. This in turn has made their currency very neutral.

The British pound (GBP): Frequently called, Cable or Sterling, the pound first got these nicknames because it was the first currency the Forex market traded through ‘cables’ across the Atlantic. The pound is the fourth most traded currency on the market and Great Britain’s economy is one of the strongest in Europe.

Canadian dollar (CAD): This currency’s unusual nickname, the Loonie, comes from the coins appearance which features a loon, a common Canadian bird, on the coins backside. Canada is a resource-focused economy, so the price of oil drives this currency along with commodities.

Australian dollar (AUD): Known as the Aussie, this currency is popular in the Forex market because of Australia’s currently high interest rates and generally stable economy. The Australian dollar is greatly influenced and driven by gold prices.

New Zealand dollar (NZD): Also known as the “kiwi,” the New Zealand dollar traditionally tracks the Aussie dollar’s path because these economies are tied together through exports. However, sometimes the New Zealand can fall while the Aussie dollar rises as we have recently witnessed.

The big news this past week was definitely the dollar. The dollar rallied the most against the euro than it has in the past eight years. The dollar index climbed the highest it has been in six months.

So the question is: What’s going on here? How can the dollar rally like this when the greenback’s fundamentals leave so much to be desired?

Let me give you my theory about what’s happening here. To really understand it, you need to start with a question:

What happened to decoupling, the idea that other economies are immune to the United States’ weakness?

Well, it seems the sub-prime fiasco created bigger problems for the U.S. financial system than everyone thought. And now we’re seeing this economic virus spread to other areas of the globe.

Need Evidence? It’s All on the Nightly News

It’s pretty easy to see other countries are feeling our same sub-prime pain. Just look at these recent news stories…

• German industrial orders dropped sharply - by 2.9% in June. That’s disconcerting considering Germany’s economy makes up one-third of total Eurozone output. And speaking of the rest of the Eurozone, many of those economies are bogged down by housing busts just like us.

• The International Monetary Fund (IMF) called out the U.K. economy. They predicted the U.K. would grow 1.8% and 1.7% for 2008 and 2009, respectively. All I have to say is: Kiss those numbers goodbye. The IMF’s latest forecast calls for a seriously lower 1.4% in 2008 and 1.1% in 2009.

• Australia is battling sluggish household spending and their financial sector is being challenged. The National Bank of Australia recently reported a huge second quarter write-down, which they blamed on massive collateralized debt obligations (CDOs).

• And the New Zealand Treasury anticipates a second consecutive quarter of negative GDP growth. By definition, New Zealand will have entered recession once official numbers are released. They’d be the second OECD-member country since Denmark to sink to official recessionary status.

The reality is that the big three in the developed world - the U.S. the U.K., and the Eurozone - are staring into the face of recession.

How Does this Big 3 Recession Affect the Next “Superpower?”

As we were so often told when analysts were pushing the decoupling theory, China is set to take over the world.

But if weakness is spreading around the globe, what does that mean for China?

The 2008 Summer Olympics are just now beginning, and there’s news that pollution has grown to far worse levels over the last few months. Chinese officials are putting all kinds of limits on how many cars can be on the road on any given day.

Additionally, in an effort to minimize excessive air pollution, Beijing is closing 105 factories. And should conditions worsen, neighboring cities could close as many as 117 factories combined.

Anticipation of the games gave Chinese companies reason to ramp up production. But what’s concerning is these companies front-loaded production and an inventory glut is building up.

It makes you wonder how much extra production was jammed into the last quarter in order to prepare for air cleansing before the great games began.

I suspect plenty.

That’s never good because they will have to sacrifice growth for as long as it takes to work through the oversupply.

It’s now the biggest imponderable for Australian business. Just as we seem to have pushed high oil prices and inflation to the back of the agenda with last week’s Reserve Bank hint of a rate cut, possibly next month, the plunging value of the Australian dollar will force us to keep oil and cost pressures in the forefront of our mind. Exporters will be having a quiet cheer, the pressures of a 98 USc Aussie dollar and the prospect of parity with the US currency, have been ended by the near 10 USc drop in the value of the local currency in the past three weeks. The Aussie fell more than 4% last week alone against the US currency and the loss since its peak last month is now well over 10%. Suddenly exporters are getting more for their exports, while importers are having to pay a bit more, including importers of oil and petrol.  Big investors feel the uS has better recovery hopes than Europe, Japan or emerging markets; even though those emerging markets are still growing and the US is sluggish. Analysts say there’s enough economic information being released in the US this week to eithger back or dash this view. It’s a view that ignores the continuing slump in house prices and forecsts that this will continue for much of the remaining months of 2008.  But the impact will be small to start with, but with the US dollar now on a major rebound against the rest of the world, a fall to below 85 USc must in mind for many analysts. The currency closed at 88.85 USc in New York early Saturday morning, down sharply from the close the previous Friday of 92.92 USc and 95.84USc the Friday before that in Australia.The dollar fell again this morning to under 88.70 US cents. Seeing the currency peaked at over 98USc in early July, it has been a very sharp fall in almost a month The US dollar’s dramatic rally this week has prompted some investors to say its seven-year slide may be over, as the focus shifts from US economic woes to the spread elsewhere of the credit crunch-inspired slowdown. The greenback had its biggest weekly gain against the euro in eight years last week. Friday saw its biggest one day gain in six weeks. The euro fell 3.6% to $US1.5005 Saturday morning, from $US1.5564 on August 1, the biggest weekly decline since January 2005.  The currency tumbled 2.08% Friday touching $US1.499, in what was the second biggest one-day decline since the introduction for the euro in 1999.

It is now US 10c below its record high above $US1.60 struck only a month ago.

The rally was driven by The European Central Bank warning on Thursday that growth is slowing, meaning no more rate rises.

It was the ECB’s 0.25% rate increase in the first week of July that prompted the drop in the value of the greenback and surges by the euro, Aussie dollar and other high yield currencies.

The NZ dollar’s rise was stopped a few days later by its central bank cutting rates 0.25% to 8% as recession took control of the Kiwi economy.

Since mid-July, oil prices have tumbled $US30 from their record peak above $US147 a barrel; Japan’s government has said the economy may be in recession, and a continuing series of eurozone indicators have signalled an impending downturn.

Italy in fact Friday revealed its economy was contracting and figures this week could signal the slump evident in Italy, Spain and Ireland has now spread across the entire 15 country eurozone.

Britain is sliding as well, Denmark has slowed and there’s now strong suggestions the German economy has gone from 5% growth in the March quarter to a probable contraction in the March quarter.

The UK pound fell to its lowest level against the US currency in more than 11 years.

The dollar also advanced elsewhere, reflecting the positive shift in sentiment towards the currency that will continue now there’s recession on the way (in the market’s mind in the US, Europe and Japan).

The dollar had solid rises against the US, the Swiss franc and the Canadian dollar as well as the pound, euro, sterling and Kiwi currencies.

After the RBA left interest rates at a 12-year high of 7.25% and signalled a coming rate cut, the downward pressure on the Aussie intensified; especially after the ECB sent its no rate rise message.

The euro’s dramatic drop last week suggests that the currency’s long-term climb - which has almost doubled its value from 2000 to last month’s record high above $1.60 - may be over.

The sharp recovery of the dollar since July is reportedly prompting investors to consider an increased focus on hedging their positions against foreign currency weakness against the dollar: a big change in sentiment in the past few days.

The sell US dollar-buy commodities lurk used to be the easiest money game in town for hedge funds and other aggressive investors after the bottom fell out of credit and equity markets.

It seems no longer, and the possibility of being burnt by a surging greenback is now all too real.

* AIG results weigh on financial sector

* Oil below $119, down around $30 from record high

* G7 recession becomes real possibility

HONG KONG, Aug 7 - Asian stocks fell on Thursday, as a sustained decline in oil prices could not shake a sense of gloom among investors about financial sector instability and the worsening global growth outlook.

European stock markets were expected to open as much as 0.5 percent lower, according to futures markets, after European insurer Allianz <ALVG.DE> warned about its profit forecast for 2009 and the world’s largest insurer American International Group Inc <AIG.N> chalked up a quarterly net loss of $5 billion.

Dealers expected Barclays Plc <BARC.L> to fall as much as 3 percent at the open after the bank said first-half profits fell 33 percent on $4 billion of write downs, though that was not as bad as expected.

The U.S. dollar slipped against the yen after jumping to a seven-month high on Wednesday. It was also slightly weaker against the euro ahead of a European Central Bank policy decision due later, widely expected to keep interest rates on hold at 4.25 percent.

Crude oil was trading just below $119 a barrel <CLc1>, having tumbled nearly 20 percent from July’s record high, as expectations for U.S. energy demand continue to deteriorate.

Concerns about wavering demand in China, whose economy has devoured natural resources for the last decade and pushed up commodity prices, also weighed on copper prices.

Lower oil prices could be interpreted as relief for U.S. consumers, on whom Asia depends for export demand. But inflation was still a global threat, bad loans continued to dog banks and insurers, and investors faced the prospect that all of the Group of Seven rich nations could slip into recession.

As a result, optimism was in short supply.

“Certainly the environment is one that should be positive, with the weaker yen and lower oil prices,” said Hideyuki Ishiguro, supervisor at the investment strategy department at Okasan Securities in Tokyo. “But the idea that Japan’s economy isn’t good is spreading.”

Japan’s Nikkei share average <.N225> fell about 1 percent, led by an 11 percent drop in shares of air-conditioner maker Daikin Industries Ltd <6367.T> after the company cut its earnings outlook because of sluggish sales in Europe.

Shortly after the market closed in Japan, Toyota Motor Corp <7203.T>, the world’s biggest car maker, said quarterly net profit fell 28 percent but it kept its forecasts unchanged.

Outside Japan, Asia-Pacific stocks <.MIAPJ0000PUS> were largely unchanged, but within sight of a 16-month low plumbed on Tuesday.

Hong Kong’s Hang Seng index <.HSI> rose 0.6 percent, lifted by a 1.7 percent rise in shares of HSBC Holdings <0005.HK>.

Cathay Pacific Airways <0293.HK> was the top percentage decliner on the index, down 4.6 percent, after the airline on Wednesday posted its first interim loss in five years.

CENTRAL BANK DILEMMA

South Korea’s benchmark KOSPI <.KS11> dropped 0.9 percent, weighed down by the financial sector after the Bank of Korea on Thursday raised its main interest rate by a quarter percentage point to its highest in 7-? years to battle price pressures.

“Clearly inflation is up, but there are massive growth risks for the Korean economy. The entire household sector and small and medium-sized enterprise sector are hugely leveraged. There is likely to be a downturn in economic growth,” said Frederic Neumann, Asia Pacific economist with HSBC in Hong Kong.

Other central banks around the world face the same dilemma — whether to tighten borrowing conditions now to stem inflation and risk a sharper economic slowdown.

Earlier this week, Indonesia’s central bank raised rates by 25 basis points for the fourth time this year, but the Reserve Bank of Australia kept its rates on hold.

The U.S. Federal Reserve held rates steady at 2 percent on Tuesday, expressing concerns about both the slowing economy and rising inflation. The Fed indicated it is in no rush to push borrowing costs higher.

That has helped to spur investors’ willingness to take risks, a primary driver in boosting the U.S. dollar to its highest level against the yen in seven months on Wednesday.

The dollar was down 0.1 percent against the yen at 109.50 yen <JPY=>. The euro edged up 0.3 percent to around $1.5457 <EUR=> ahead of the ECB’s meeting later in the day.

The potential for a global recession was lurking in the minds of many investors, with a steady stream of bad news out of the corporate sector and economic data indicating a recovery has not arrived yet.

“All the G7 economies are now in a recession or headed in the short run towards a recessionary hard landing,” said Nouriel Roubini, chairman of RGE Monitor, a New York economics research firm, in a blog posting on Wednesday.

“While the world will technically avoid a global recession it will get quite close to it by mid-2009 as global growth will slow down to a near recessionary 3 percent.”

Japanese government bond futures briefly hit a four-month high on concerns about the outlook for Japan’s economy and due to a fall in Tokyo share prices.

September 10-year JGB futures were down 0.08 point after earlier rising as high as 137.46 <2JGBv1>, the highest level for a lead futures contract since late April.

Gold <XAU=> was up 0.6 percent at $883.95 an ounce, but still more than $100 cheaper than in the middle of last month.