WHY DO OUTFLOWS INCREASE AS FOREIGN CURRENCIES WEAKEN AGAINST THE DOLLAR

Outflows are caused by interest rate differentials and exchange rate changes As foreign currencies weaken against the dollar, foreign interest rates become more attractive and foreign securities become cheaper When the foreign currency strengthens, interest rates and bond prices fall This is also true for bond investors in the U S If they see the dollar strengthening, they increase their purchases of foreign securities for sale in their countrys currency When interest rates and yields in the U increase, investors in the U have less incentive to invest in foreign securities and vice versa There are also the relative returns on bond investments An investor in the U may have a higher return on bonds of a domestic corporation than on government bonds of a foreign country This is due to the fact that a diversified portfolio of corporate bonds may have a higher return than an equal-dollar amount of foreign bonds of a diversified portfolio The investor must compare the difference in the risk of the two bond portfolios If the risk is the same or nearly so, then the investor would choose the higher return Finally, there are investment decisions based on the expected currency movements When the dollar is strengthening against the Japanese yen, Japanese investors may be more likely to sell yen and buy dollars As the dollar strengthens against the yen, the Japanese investor will expect the yen to depreciate against the dollar in the future This is called a carry trade The investor borrows yen at a low interest rate, converts it to dollars and invests the dollars at a higher interest rate The investor hopes to make a profit on the interest rate differential The carry trade is only profitable when the dollar is strengthening against the yen If the dollar is weakening against the yen, the investor will be losing money Which has a greater impact on capital flows, interest rate differentials or exchange rate changes? Interest rate differentials and exchange rate changes have a greater impact on capital flows Exchange rate changes have little effect on capital flows This is due to the fact that many international investors are not currency speculators They are usually long-term investors who do not respond to short-term changes in the exchange rate What is the difference between a short-term and long-term investor? A short-term investor is an investor who invests in a security for a relatively short period of time The fed policy of new zero interest rates narrows the gap between short term and long term bond rates . The Banks profit margins decrease to less than 1 percent . Fear of default increases from the intense demand by shareholder for earnings . Dollar carry trade occurs when bond yields become extremely low , bond prices go up on borrowing by speculators . The speculators borrow dollars to invest in Australia , South Africa , and Japan . The dollar index declines from lack of foreign demand . The buying power of the dollar is less and imports cost more money . More money is financed from foreign countries . Speculator take short term profits by shorting the dollar betting on its further decline due to increase deficit spending and rising inflation and taxes . Manufacturing production declines during periods of high interest and taxation shifting more jobs overseas to capture profits .