A Falling Dollar

People used to use the expression “sound as a dollar.” Seems pretty quaint, doesn’t it, with the dollar losing value almost every day? It is off about 13 percent against the Euro since May of this year. It has slid by similar amounts against the Japanese yen and the Canadian dollar. This trend has gone on without much notice from the general public, but it raises some interesting questions.

First, is it good or bad? That depends on whom you are talking about. A U.S. resident planning a trip to Europe will find that a Euro will cost about $1.30 or more instead of just about 80 cents, as it was priced a couple of years ago. About the same for the British pound. Paying $4 or $5 for a cup of coffee and several hundred dollars for a decent restaurant meal will be a quick reminder of the new reality. And if you are thinking of buying a Japanese, German of French car, watch out for hefty price increases. But American merchants, who increasingly outsource their purchases, are often finding cheaper supplies abroad and thus boosted earnings.

What causes the dollar to keep sliding? Economists say it results largely from two steadily growing deficits – in foreign trade (what is bought compared with what is sold) and the federal budget (spending compared with revenue.) Both have reached record highs and are still growing. And the trade gap jumped especially in October, with imports exceeding exports by more than $55 billion.

Why would anyone want to keep the dollar going down in value? Mainly because this makes American exports cheaper to buy and tends to make new jobs here at home. Some financial analysts think the dollar has been overvalued and a gradual readjustment downward is a good thing.

Then why doesn’t President Bush say so and explain these benefits, instead of insisting that he stands for a strong dollar? Because if he said so it could make the dollar look weak and could cause foreign countries to slow their buying of U.S. government bonds. Thus DailyFX, an online foreign exchange educational and trading service, says the United States is forced to “run a clandestine weak dollar policy.”

Is there any danger in the present course? Possibly. The United States needs a net inflow of foreign capital of at least $1.8 billion per day to finance the large and growing current account (budgetary) deficit that results mainly from the unexpected high cost of the war in Iraq and the massive tax cuts. DailyFX warned recently that smaller than expected inflows of foreign capital “offer a possible signal that the deficit may be becoming unsustainable as foreigners lose their appetite for U.S. assets.” It noted that Japan was a net seller of U.S. securities in one month. Other reports said that Russia was considering converting some of its $117 billion foreign currency portfolio from dollars to Euros.

Since the dollar is the world’s premier reserve currency, a steeper slide in its value could conceivably trigger a worldwide recession. That gloomy possibility is off in the indefinite future somewhere, but international bankers and analysts seem increasingly concerned about the growth of the twin U.S. deficits.