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July 22nd, 2011 @ 4:41 pm by Michael Radkay

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BY MICHAEL RADKAY

It was May 12th 1999 and I was trading 30 Year Bonds at the time. Long the market with price running in my favor; things were looking great!! But all of a sudden the foundation on my long play started to buckle. Price began dropping dramatically! WTF!!!  The dollars I was up evaporated and now were running substantially negative. Instead of taking the loss I elbowed the guy next to me and asked “What’s Going On?” He didn’t know… WTF!!! In my hesitation and stubborn mind-set to admit my loss, it grew to a larger deficit because like everybody else we have this deep desire to know why we are wrong and do everything in our power to not admit it. Sound familiar? This is not what champions do! But every champion needs to learn this very lesson I learned 12 years ago. My hesitation angered me upon reflection that evening, because I didn’t need to know the reason why in the heat of the moment; price action told me something just happened. I’m sure if you were in the middle of the Iraqi desert and somebody started shooting at you, your first instinct wouldn’t be to ask your buddy, “Whats Going On?; your initial reaction would be to duck and hit the dirt to avoid getting hit. After watching and actively trading in the market, you build a sense of when something is up. Well in this case the Treasury Secretary of the time, Robert Rubin decided to resign that day. This created a negative effect on bond prices. Even if my neighbor knew the reason the mere fact of asking while in a position created the hesitation and the increased overall loss.

I learned from that day forward to stop elbowing my neighbor to find the reasons why.  I began to cover the bad idea when price action got volatile and turned negative and I began to breath and hang on to the trade if it went in my favor. I asked why later on both accounts. This approach is highly effective because price action always tells you the truth by watching it. It reveals where to buy and where to sell (lows and highs respectively). As price action revisits these areas just remember them and play accordingly favoring the side that is winning. You will also begin to notice when price tends to move at normal speeds (after economic reports are absorbed), fast speeds (during reports or significant world events) and slow speeds (lunch time or bedtime). Watch and remember.

Price never lies to me because I have never met an investor or trader that gets into a trade in hopes of losing money. If you don’t agree with what I just said, I’m sure you will tend to agree with me on this point after I explain it a bit further. When price moves up or down, somebody bought and somebody sold. Money is on the line and the only thing left is to be right or wrong. This is the purest moment as a trader as you are not an arm-chair quarterback anymore. As price moves the winners hang on and might even add more to the idea as their money builds and the losers cover the idea to minimize loss and, if they try again in the same direction they cant play as hard because their resources and nerves have taken a punch to the gut. The losers didn’t go in thinking they were going to lose but they eventually have no choice but to join forces with the winners as their accounts dwindle or margin calls come into play. The losers in reality add fuel to the winners fire! This helps me conclude that price cannot lie. It can get over inflated and you might not agree with it but just try and fight against opponents that have unlimited resources.

People and traders naturally gravitate towards a side, the winning side. Lets look to the U.S. Dollar as an example. It is no real news that it has been getting beat up. Lets compare it to the EURUSD (Euro/US Dollar). Since the EUR is first in the pairing and knowing that the news and the outlook to date have been bearish for the U.S. Dollar in-turn bullish for the Euro. Traders are betting that the US government will raise the debt ceiling and allow the U.S. to borrow and spend as usual in hopes of getting our economy on the right track. Whether you agree with it or not is not the point. If the debt ceiling is raised interest rates will remain low in the U.S., confirming the already in place weak U.S. Dollar trend against other currencies. Now of course if the government and congress fail to act we may begin defaulting on our debt which is something my eyes have never seen. It will be interesting but I don’t think it will be entertaining. Economists say that this can create a reverse effect and cause a spike in interest rates as investors will not be attracted to loan the U.S. money receiving such low rates especially if their is default risk. A dose of higher interest rates in a bad economy would not paint the best picture.

Now removing all of the political game playing and can’t trust a word she said/he said debate, lets concentrate on price as it removes the bias and tells the real story. When money is placed on the table and in play; long or short, there is no turning back. Since we can’t move prices ourselves to the desired spot for entry and exit, we need to jump on the backs and watch where the market movers (governments, banks, large financial institutions, hedge funds etc…) fight for control. As the dust settles and a direction is being established we adjust along the way according to the tops and bottoms that are being established. As the range is identified, I’m sure you all heard of the concept buy low and sell high or sell high and buy low; pick the side of the winners and wait for price action to revisit the last known extreme and jump on board. I have provided an example of the action on the EURUSD to illustrate how you can watch tops and bottoms develop. In this case it has been a better idea to go long the EURUSD based on what price has been doing since January 2011 (see EURUSD daily chart 2011). Now lets look at an intra-day 5 minute chart 07/21/11 and see if we cant identify some short term buy opportunities (see EURUSD intra-day 5 min chart).

Our definition of true happiness is actually trying all of the things in life that you say you wanted to try. The result doesn’t define happiness, but the act of trying does!  Whatever you decide to try; you can’t win, if you don’t play!! Prosperity is at your fingertips! All you have to do is grab it!!

Trading Commodity Futures and Foreign Currency (Forex) contracts may not be suitable for all investors. You may lose a substantial amount of money in a very short period of time. The amount you may lose is potentially unlimited and can exceed the amount you originally deposit with your FCM. The material in this newsletter and on our website is intended for educational purposes only.

© 2011 RDS Trader, LLC.  Have a specific topic you want to read an article on, email us your requests! info@rdstrader.com

WANT TO USE THIS ARTICLE IN YOUR E-ZINE OR ON YOUR WEBSITE? You can, as long as you do not alter the article in anyway and include a credit that reads: Financial Experts and Mentors Mike and Stephanie Radkay publish RDS Trader E-newsletter. If you are ready to ‘Take back your power, Invest with confidence and Protect your assets’ get your free tips now at www.rdstrader.com

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June 24th, 2011 @ 7:04 pm by Michael Radkay

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“Teed-Off or Green With Envy?
BY MICHAEL RADKAY

 

Did you ever realize when you go to a golf course your see people jammed at the driving range and wanna be golfers with their drivers trying to hit the ball 300 plus yards? Pretty common scene. I look at the packed in driving range and then take a glimpse over at an empty practice putting green. Typical scene as well.

The reason in my opinion is that putting is not a glamorous part of the game as it takes finesse and touch, but the driver speaks a loud language as you can GRIP IT AND RIP IT! Nobody seems to want to slow down and think and analyze the break of a putt. Too easy, right or is it too hard? Grip it and rip it or touch and finesse, which side of the fence do you swing on? Sounds like advertising doesn’t it?; as you never see commercials saying they have the best golf ball for putting; you only hear about the best ball that will ensure you drive it straight and long…mmmmm…

These things are not too much different than what you see advertised in trading the forex, futures or stock markets as well. Trade the reports!, Trade the FOMC!, Trade the Unemployment report with a Pro type of thing. CNBC even has a clock countdown before these reports are expected adding to the excitement. Advertising and marketing teaches you to go after in my opinion the wrong thing initially. Have you ever heard the saying “Drive for show and putt for doe $$”? Nobody seems to listen to those golf pros that shout those words. Wanna be golfers yell at their instructors to teach them how to hit the Big Dog like John Daly, Tiger Woods and now Rory Mcilroy.

Nothing feels better I guess than taking a big swing with those sledge hammer drivers in hopes of connecting to hit the long ball. I have watched people take a big bucket of balls and attempt swing after swing as balls fly way left and way right and some even dribble 2 feet away. Occasionally you see a nice one but then things soon get right back to the norm as balls fly way left and way right and dribble 2 feet in front again.

It is the same in trading, teach me how to make a million trading those FOMC reports or Unemployment numbers when the action is quick and fast and pays huge dividends. You hear slogans like ‘you don’t need to know anything or our software will do everything for you”…Warning!! Warning!! I cant say it enough times how this doesn’t prepare you for the other 23 hours and 59 minutes each day. The repercussions to your trading account trying to hit the long ball all of the time is a recipe for a disaster, because when you are wrong just once (and you will be), you wont come back. Begin to take notice on the fine print on the latter half of the popular saying; drive for show, putt for doe $$. Trading the financial reports day one during the volatile moments is so much like running to the driving range or golf course and picking out the driver first thing and trying to rip it down the fairway. Good luck trying that! As far as my eyes have seen from the one hit wonders that I have come across in the trading business is that they never produce lasting consistent results. Even when the one hit wonders connect, the greed consumes them and not long after you hear or read news of their bankruptcy.

I wonder why people don’t practice putting first or our trading equivalent with $0.10 pips per contract? The pendulum motion in a putting stroke is a fraction of the big driver swing but nonetheless the beginnings of the same motion. Just as a $0.10 pip per contract is the same game as the $10 pip per contract. Same price action just only a fraction of the cost while you gain your confidence and your swing.

As you control your putting rhythm and finesse you get better and better. You begin to place yourself in a position to sink the putt or at least get yourself in a 1 to 2 foot radius for a 2-putt at worse (a great goal!). Slow your roll so to speak :) that’s how we roll :) Reward yourself with the driver at the range or on a live round, if you can 2-putt everything on the practice green. Then begin to increase the pendulum motion at the range and hit the wedge, then the 9, 8, 7, 6, 5, 4, 3, 2 irons and then the hybrid wood, 3 wood and finally the driver (notice how its last). Your confidence will be better as you get in a groove with the easier to hit irons first. As you begin to trust your swing at the range you will naturally move up to the harder to hit clubs with experience and begin to create something that will last a lifetime and produce lasting results on the course.

Wait a minute; am I talking about trading? I think so…start with the motion of learning the environment on a practice account (practice putting green), once you know how to use the equipment start trading on $0.10 pips per contract (the irons) and then as you see progress you move gradually up to the $10 pips per contract trades (the driver).  You will enjoy the “Show” and not get Teed-off in the beginning. Your friends will be green with envy, when you play it smart from tee to green and from open to close.

Whatever you decide to try; you can’t win, if you don’t play!! Prosperity is at your fingertips! All you have to do is grab it!!

Trading Commodity Futures and Foreign Currency (Forex) contracts may not be suitable for all investors. You may lose a substantial amount of money in a very short period of time. The amount you may lose is potentially unlimited and can exceed the amount you originally deposit with your FCM. The material on this website is intended for educational purposes only.

© 2011 RDS Trader, LLC.  Have a specific topic you want to read an article on, email us your requests! info@rdstrader.com


WANT TO USE THIS ARTICLE IN YOUR E-ZINE OR ON YOUR WEBSITE? You can, as long as you do not alter the article in anyway and include a credit that reads: Financial Experts and Mentors Mike and Stephanie Radkay publish RDS Trader E-newsletter. If you are ready to ‘Take back your power, Invest with confidence and Protect your assets’ get your free tips now at www.rdstrader.com

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November 19th, 2010 @ 1:27 pm by Matt "NewstraderFX" Carniol

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What I wanted to say in the title was “The Party of No,” as the Republicans have come to be known, by using the Chinese symbol for “no” (which I could not do because the editor doesn’t allow Chinese symbols).

Because of their intense, anti-Obama obsession, Republicans and the Tea Party (which is led by Sara Palin) are now on the side of China as far as U.S. monetary policy is concerned. Talk about politics making strange bedfellows!

Why? Well, if a policy has anything to do with President Obama, the Republicans are reflexively against it even if, as in the case with China and QE2, being against that policy aligns the Rabid Right with the wants and desires of our economic opponents.

What this means is that, in essence, Republicans and the Tea Party are allied with the world’s biggest currency manipulator simply because it suits their anti-government, anti-Obama, and anti-everything agenda.

In any event, the thought of Sara Palin making recommendations on monetary policy is truly frightening, at least to me. And since she is one of the likely presidential candidates in 2012, her amateurish meddling bodes poorly for the idea of a politically independent Federal Reserve, should she indeed manage win office.

The idea of QE2 being some kind of radical policy is grossly misplaced to begin with. The Fed is always in the business of either creating or destroying money, depending on whether it needs to loosen or tighten policy, which it does by either buying or selling T-bills. The main difference with QE2 is that policy is being implemented via longer term Treasury obligations, which are the only instruments available to use since nominal short term rates are up against the zero bound. Additionally, the Fed should have little if any problem tightening policy if and when the time comes because Treasuries are so liquid.

Curiously, economist John Taylor, he of the Taylor Rule, is also against what the Fed is doing even though his rule is currently saying that policy should be more loose than it currently is, even with the full $600 billion of QE2 applied (if you accept William Dudley’s assessment that QE2 is equivalent to between 50 and 75 basis points of easing).

The Taylor Rule is a mathematical formula that forecasts the target federal funds rate using the current annualized inflation rate and the difference between the current unemployment rate and the Non-Accelerating Inflation Rate of Unemployment (usually estimated at between 5.5% and 6%). According to the Taylor Rule, spikes in unemployment above the natural rate call for lower interest rates, especially when inflation is subdued.

Christopher L. Foote, an advisor to the Boston Fed’s Center for Behavioral Economics and Decision Making, said on Sep. 10 that interest rates should stay low for the foreseeable future, and the Fed’s use of non-standard monetary policy to bolster liquidity will likely continue.

According to Foote, the Taylor Rule is saying that the target federal funds rate should be in the range of negative 3.5% to negative 4.5%. And since the federal funds rate cannot fall below zero, Foote said, the Federal Reserve will probably continue to employ unconventional monetary policies to encourage bank lending and increase the money supply beyond what its normal toolkit would allow, which is now what it is doing.

As Foote noted, the Taylor Rule’s forecasts have correlated closely with the actual target federal funds rate over the past decade (see Figure 1), even though the Fed does not explicitly follow the rule.

Here then is a crude estimate of where policy currently is, taking into account the $1.7 trillion of QE1 and the full $600 billion of QE2, using Dudley’s estimate of 50 to 75 basis points for each $600 billion of quantitative easing:

The $1.7 trillion from QE1 represents about 142 to 212 basis points (1.42% to 2.12%) of easing and QE2 adds another 50 to 75 basis points (0.5% to 0.75%). That brings the total amount of interest rate reduction for QE1 + QE2 to between 192 and 287 basis points, meaning that the nominal target rate has been lowered to the equivalent of between negative 1.92% and negative 2.87% which, according to the Taylor Rule, is still too restrictive. So, despite the fact that Taylor’s own rule indicates that the Fed should be doing even more, he’s come out against further quantitative easing!

What’s interesting about the above chart is that it indicates Fed policy was too loose during the 2003 to 2007 period, when the housing bubble was being created.

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November 18th, 2010 @ 11:45 am by Matt "NewstraderFX" Carniol

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As veterans of the financial crisis wars in the Great Repression, the Irish version of “take the EU/IMF money and run” just doesn’t have the same panicky feel as the Greek April-May tragedy.

In other words, Ireland seems to have somewhat of a “been there, done that” feel in that the situation doesn’t seem like an out of control lurch into the depths. S&P futures were rising 12 points heading into Thursday’s NY session and the dollar resumed declining against the euro, pound and Australian dollar.

This time, there just doesn’t seem to be concerns that the single currency is in imminent risk of collapse as there was back in the Spring, on the belief that the European Union will do whatever it takes to keep the currency together, as it has done it before.

The charts seem to bear this idea out; EUR/USD has found support after making a neat little 50% retracement of the upswing against the dollar which resulted in no small part from speculation regarding QE2. It’s also gained against the Australian dollar, Canadian dollar, and even the Brazilian real.

According the Bloomberg, Irish central bank Governor Patrick Honohan on Thursday said he expects the country to ask for a bailout from the European Union and the International Monetary Fund worth “tens of billions” of euros to rescue its battered banks and probably pay an interest rate close to 5%.

“It is my expectation that will happen, absolutely,” said Honohan.

Irish bonds rose after the remarks, according to the article, pushing the yield on the country’s 10-year debt down 10 basis points to 8.22 percent as of 9:43 a.m. in Dublin. The spread over benchmark German bunds narrowed to 537 basis points from 554 basis points Wednesday after hitting a record 652 basis points on Nov. 11.

Also helping markets early Thursday was the successful (7 to 1 oversubscribed) initial public offering of General Motor’s stock, one of the biggest in history.

Still, there’s scope to see concerns over Greece resurface.

Bloomberg reported on Thursday that Greece may raise its deficit forecast during the day when the government outlines plans for the 2011 budget, therefore failing to meet the terms of the 110 billion-euro bailout that saved it from default earlier this year.

It seems as if Greece will not be able to meet its revenue forecasts, which means that it won’t be able to reduce its budget gap to 7% of GDP from 9.4%.

Austria threatened on Nov. 16 to withhold its contribution to the bailout, and Greek 2-year government bonds rose 70 basis points to 11.96% before falling 50 basis points on Thursday.

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November 16th, 2010 @ 11:55 am by Matt "NewstraderFX" Carniol

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I wrote an article back on Nov. 5 entitled “Bearish Divergence All Over The Place” that predicted a come-back for the dollar and at this point, it looks as if the retrace of the move which began on Sep. 9 has some room to run as traders reverse their bets against the dollar. The subject was also covered in my Nov. 1 article (The Dollar Should Gain After The Fed).

Data from the Chicago Mercantile Exchange (CME) show that while traders reduced their extreme dollar short positions slightly after QE2 was announced on Nov. 3, they are still holding shorts at near-record levels. But with Treasury yields now rising rather than falling, the risk of sovereign defaults in Europe increasing, and with euro-zone growth about to falter, support for the dollar is likely to increase as the huge number of short positions is covered.

First, Treasury yields are rising as traders get out of bonds on the fear of Fed-induced inflation, something I covered in another article (The Fed’s Radical Shift). Next, economic data coming out of the U.S. since the Fed’s announcement has greatly improved and if Monday’s report on retail sales is any indication, things are likely to gain momentum heading into the end of the year. Third, the rise in bond yields will make the dollar even more attractive in an uncertain world where investors continue to look for higher but safe returns, especially after data from Europe over the last several weeks has shown that growth in both Germany and France is slowing down rapidly.

In other words, all that talk that the ECB will be able to remain hawkish while the Fed resorts to more easing looks a little premature. The ECB could now well find itself considering further measures to ease credit conditions as the central bank has already been forced to provide European banks with much more short-term funding than expected in recent weeks.

In looking at a chart of the euro, I’ve placed a fib study which covers the euro’s latest run and indicated the previously-mentioned bearish divergence. The short trade was entered in my Trade Room as a pending order which was issued at the close of trading on the 15th based upon one of my main goals in trading: sell high (if possible) which means in this case that I was looking for a move up to the 38.2 fib level, where resistance was likely to be found.

The target for this trade is down near the 61.8 fib level because I’m looking for something I’ve frequently seen to repeat; whether the retrace I am looking at is up or down, once price closes past the 38.2, it is very common to see it eventually move to the 61.8. It also is very possible to see to see the 38.2 tested as resistance again over the next few days.

A more conservative target would be to the 50% level and indeed, I’ll look to reassess this trade should the euro move there.

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November 12th, 2010 @ 4:17 am by Matt "NewstraderFX" Carniol

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In the first installment of this article, I wrote about bearish divergence on the EUR/USD and AUD/USD  pairs and provided a couple of charts. I also mentioned that a bearish divergence existed on gold, while a bullish divergence was seen on the chart of USD/JPY.

In my trade room, we’ve just taken a long in this pair based purely on the following technical indicators and price actions:

1.       Where price sits in relation to a fib study I have

2.       The way  price has moved in the first few hours of Friday’s trading

3.       The bullish divergence

4.       The Deliman indicator

For those of you unfamiliar with the term, “deliman” refers to the person who works behind the counter at a delicatessen slicing cold cuts and making sandwiches. And as much as I enjoy talking sports with my favorite deli man, an area in which he displays quite an expertise, when it comes to forex trading let’s just say that he wouldn’t know the difference between the ECB and the planet Krypton. And yet, like pretty much everyone else these days, he’s very concerned about the dollar’s decline and is “pretty sure” that it’s about to depreciate into oblivion. For goodness sakes, he’s even become familiar with the term “quantities easing,” and is now very nervous about the government’s plan to “crank up the printing presses!”

Not that I mean to sound like some kind of currency snob, but when people who hadn’t heard of the Federal Reserve until last week start telling me their opinion on currency movement, that’s pretty much all I need to hear in order to make a decision to get out of the previous trend. In other words, the “Deliman indicator” is one of the best contrarian signals known to man.

As far as the other factors in this trade are concerned, as you can see on the chart, Thursday’s trade closed above the 14.6 fib line, which I take as a sign the nascent bullish trend on the pair will continue. What’s also happen is that early in Friday’s trade, price has retraced 61.8% (in pips) of  Thursdays range, which was to 82.25, and has found support there (Friday’s low, to this point was 82.22). The bullish divergence was made 9 days ago when price made a lower low and the MACD made a higher low.

The stop is about 10 pips below Friday’s low and the target is just below the 23.6 fib level, which gives this trade a nice little 5:1 reward to risk ratio. Actually, there’s no reason not to think we can’t get to the 38.2 eventually, but there should be another chance to get in later.

*Extra Credit:

Check out how the day the BOJ intervened turned out to match up with the 38.2 retrace level.

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October 27th, 2010 @ 11:33 am by Matt "NewstraderFX" Carniol

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For those of you interested in trading news releases, looking for price to retrace may or may not be “new news.” However, saving some pips here and there, no matter how small, will greatly enhance your profitably over time and minimize you risk.

Why? Because even if waiting for a better price means only a 10 or 15 pip difference, over time this will add up to a huge amount of “extra” pips for you. Saving even 5 pips over your next 10 trades is exactly the same as earning an additional 50 pips, so this really should be a no-brainer for any trader looking to maximize profits and minimize risk.

Waiting for a better price to trade at is another way to get back at your broker (or trading adversary, as I prefer to call them), because brokers place a “tax” on you when you get in and when you get out by constantly slipping you. Two pips here and 3 pips there really add up over the longer-term-think of it as “death by 1000 paper cuts.”

Trading the news by entering on the proper retrace levels can be done pretty easily using Fibonacci on the 5-minute charts and, and here are a couple of examples:

On October 25, there was a report on producer prices from Australia which showed that wholesale inflation rose more than twice as expected (1.3% vs. 0.6%), an amount that’s certainly enough to get anyone thinking about another rate hike from the reserve bank of Australia, which is already in a tightening cycle.

Now, in my judgment, this was a large miss so there definitely was a chance to see AUD/USD run higher without much retrace. In fact, the number actually gave me that “bubbly feeling.”

I’m sure you will recognize this feeling very easily-it’s the feeling you get when you are so anxious to enter a trade, your fingers are slipping as you try to manipulate the mouse. For me, that is always the worst time to trade because it inevitably means that I’m about to enter a trade that will immediately move against me!

The idea in placing the fib is to use the first candle after the news and then wait for price to peak. The level I am looking for price to retrace is the 38.2.

As you can see, price never got to that level although it tried. But what did happen is that price closed almost exactly on another level-the 23.6. So in my trade room, that became the entry.

On the 27th, there was a mild disappointment on Australian CPI (0.7% vs. 0.8%). Not a huge miss by any means in my opinion, but obviously more than enough to get nervous investors thinking that the RBA might delay its next rate increase if you look at the decline on the first candle.

In this case, price came close enough to the 38.2 to trade it. But even if you miss it there, with the next candle resuming the downward trend and closing below the 23.6 gives you enough indication that price is about to resume declining.

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October 25th, 2010 @ 1:08 am by Matt "NewstraderFX" Carniol

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Leaders at the Group of Twenty meeting in Korea made several important steps toward guarding the still-fragile global economy; a framework for realigning trade imbalances and a pledge to refrain from competitive devaluation (a currency war).

Perhaps more important is what was left unsaid. Since August 27, when Fed Chairman Ben Bernanke first intimated that the Fed was willing to provide more liquidity in the form of a second round of Quantitative Easing (QE2), the subsequent depreciation of the dollar has caused an enormous amount of capital (hot money) to flow into the rapidly expanding emerging economies, a situation that works to appreciate the local currency and to increase the risks of asset bubble formation.

For example, the Korean won has gained 7.6% over the last 3 months while the Malaysian ringgit and the Thai baht have risen by 11% and 12% respectively this year.

According to the Institute of International Finance, net private capital flows to emerging Asia were forecast to reach more than $270 billion in 2010 and as much again in 2011 even before Mr. Bernanke indicated his willingness to print. The World Bank said in June that such inflows of capital were posing a growing risk to East Asian macro-economic stability.

Aside from interventions in currency markets, some countries (notably Brazil) have recently implemented controls on capital in an effort to stanch the inflows. Such controls can take the form of taxing foreign investment in government bonds, for example.

So while it appears, at least for now, that an agreement has been reached in terms of refraining from competitive devaluation, by not mentioning capital controls the G-20 communiqué still leaves the door open for the emerging market economies to react to these dangerous inflows (which are due in large part to the Fed’s new willingness to start printing dollars again) by using them.

This situation regarding capital controls is exactly what is wanted now by the Fed and the Treasury. Here’s why:

QE2 will be of little use to the U.S. economy if these enormous capital flows, in a search for yield and return, persist towards the emerging markets, which is exactly what would continue to happen as QE2 becomes a reality in the absence of capital controls. The idea, then, is to somehow encourage as much of the liquidity that the Fed will create to circulate within the U.S. as possible, and that is where controls on capital flows by foreign governments will come into play.

The difficulty is that normally, rising interest rates and an appreciating currency is the recipe for attracting domestic and foreign investment, two ingredients which are likely to be in short supply as the Fed cranks up the presses (an important reason why, no matter what, the policy of the U.S. will be to have a “strong dollar”). For this reason, the Fed will need to create inflation, or at least the expectation of higher inflation, in order to attract net capital flows away from the emerging markets and into the U.S.

A test of these ideas could be forthcoming as early as this week because South Korea is expected to enact some form of tax on foreign investment.

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