The Declining U.S. Dollar

Abstract

The U.S. dollar has been declining in value, becoming less attractive to investors.  Nevertheless, the economy of the United States is expected to benefit from the decline of the U.S. dollar.  This is because the U.S. is facing a current account deficit, and the declining U.S. dollar would allow the country to increase its exports, thereby allowing it to easily balance its current account.  Moreover, the importance of the U.S. economy to the global economy would not permit the U.S. dollar to decline beyond expectations.

Introduction

The United States is a major importer and exporter of goods and services.  International traders recognize that imports and exports meet the differences in needs and tastes across nations.  Moreover, one country may be particularly rich in terms of a natural resource, while another may have lower than average costs of production.  Through fair trading of goods and services, all nations are able to meet their needs and be of benefit to the global economy (Samuelson & Nordhaus, 1998).

The current account balance of a nation includes all imports and exports of goods and services, investment income, and transfer payments.  The trade balance forms a part of the current account balance and consists only of merchandise imports and exports (Samuelson & Nordhaus).  The United States, in recent years, has persistently experienced a rise in its current account deficit, including trade deficit.  This implies that the country is importing more goods and services than it is exporting.  Naturally, the nations that are acting as exporters of goods and services to the United States are benefiting in the process through increased balances of U.S. dollars in their foreign accounts.  An increase in the supply of U.S. dollars outside the United States would lead to an excess demand of goods and services on the part of countries that have accumulated enough foreign exchange.  This excess demand may have to be met by increased prices of goods and services, either in the countries involved in such foreign trade, or globally (Pace, 2004).  Similarly, the fact that the consumption of foreign goods and services in the United States is tremendous, raises the likelihood of global inflation.  Furthermore, a current account deficit makes the country a major debtor, given that the country does not sell enough of its own goods and services in the foreign market to be able to afford on its own the vast consumption of its peoples.

One of the significant factors in international trade is the foreign exchange rate.  This rate is undoubtedly tied to the prices of goods and services that are imported and exported.  A declining rate for the U.S. dollar means that a country importing U.S. goods would find these goods cheaper than before.  Zoakos (2003) reported that the U.S. dollar depreciated or declined in value by 23% against the index of all major trading currencies, and by 38% against the Euro, between January 31, 2002 and June 15, 2003.  And, in January 2004, the dollar declined in value once again (Dettmer, 2004).  This made U.S. exports cheaper to other countries.  The United States hoped to reduce its current account deficit and trade deficit through the decline of the dollar, for it is obvious that making U.S. goods and services cheaper to foreign importers may very well increase the demand of U.S. goods and services, thereby fueling the growth of the U.S. economy.

In this paper we seek not only to understand the processes related to the declining value of the U.S. dollar, but also to note the challenges that face the U.S. economy in the face of the persistent depreciation of the currency.  Would a reduced price of the dollar in foreign exchange markets truly beat the persistent problem of the current account deficit that the United States faces?  Or, are there factors involved that may disrupt the process?  Seeing as the United States acts as a global leader in business, these questions are essential to answer.

A decrease in the demand for U.S. dollars can lead to a depreciation of the value of the currency with respect to another country’s currency.  The demand curve for U.S. dollars is pushed downwards in this scenario, and the new equilibrium of the demand and supply curves reveals the new, reduced rate of the dollar with respect to the other nation’s currency (See Appendix).

According to Mann (2004), the high growth in Japanese, European, and other markets around the world, especially during the late 1990s and early 2000s, led to a fall in the demand for U.S. exports.  This is, of course, an important reason why the country is experiencing current account and trade deficits.  What is more, the U.S. dollar was appreciating through the late 1990s to 2001.  This made U.S. exports more expensive, thereby further augmenting the current account imbalance.

The chairman of the Federal Reserve believes that the increasing foreign debt of the United States is a “long-range problem (Pace).”  This problem is compounded by the fact that the United States does not trust the trading methods of a variety of nations, constantly insisting on fair practices in international business, which many countries find difficult to respond to (Pace).  Given the circumstances, the declining value of the U.S. dollar appears as a blessing.  The U.S. government believes that the fall of the dollar would lead to an increase in exports of U.S. goods and services, and this increase would foster economic growth.  However, the government is not paying much attention to the idea of curtailing its own spending, neither is there a sign to indicate that the U.S. consumers of imported goods and services have begun to curtail their spending (Dettmer).  In order to reduce or eliminate the current account deficit, these conditions must be met to boot.  Otherwise, the value of imports of foreign goods and services in the United States would remain at a level that is higher than the money generated through U.S. exports, required to meet the demand of the nation without resorting to foreign debt.

 Even so, economists remain optimistic that the fall of the U.S. dollar may continue boosting the U.S. economy.  The following is an excerpt from a report published in Washington Post in September 2007:

The dollar extended its slide against the euro, hitting a new record low in expectation of a rate cut from the Fed, which would make the U.S. currency a less attractive investment  vehicle.  The dollar also weakened against the yen.

However, rising energy prices and a falling dollar have some advantages on Wall Street.

High energy costs evince strong global demand and boost the profits of oil and gas companies, while a weaker dollar benefits U.S. companies that draw revenue overseas (Associated Press, 2007).

Along with its declining dollar, the United States is experiencing a low level of interest rates that reduce the appeal of investing in the dollar “at a time when the United States desperately needs to attract growing sums of overseas investment (Dettmer).”  The low level of interest rates is actually one of the reasons behind the decreased demand for the U.S. dollar that has led to the depreciation of the currency.

We would normally expect inflation because of the declining value of the dollar, and therefore, an increase in U.S. exports.  However, Federal Reserve Governor Ben Bernanke has pointed out that there is “little threat of inflation,” seeing that the low level of interest rates does not allow for much investment in any case (Dettmer).  If the Federal Reserve were to increase interest rates in this situation, inflation may very well ensue, given that both U.S. exports and U.S. investments would become very attractive to international businesses, raising the demand and the prices in the process.

The euro happens to be a major competitor of the U.S. dollar today.  As the dollar weakens, the euro is strengthened, making it difficult for Europeans to export much of their products and services (Dettmer).  This acts as a deterrant to U.S. imports from Europe, helping the current account balance by reducing American spending on foreign goods and services.  At the same time, a strong euro means that there will be more investors in the world willing to invest in the euro as compared to the U.S. dollar.  As a matter of fact, the euro is an important reason for the reduced demand of the U.S. dollar in recent years.

In January 2007, Business Week had published a report on the declining value of the U.S. dollar, indicating that the U.S. economy is in good shape despite the falling U.S. dollar in the face of its competitors.  The following is an excerpt:

Back in 2002, billionaire investor George Soros boldly warned that the U.S. dollar’s value could plunge by a third over the next few years.  He was pretty much on target.  Since the greenback’s peak in early 2002, it has dropped 35% against the euro, 28% vs. a trade-weighted basket of major currencies, and 18% vs. the currencies of all countries the U.S. does business with.  What’s interesting is, nothing bad happened—except maybe for those investors who didn’t sell the dollar short, as Mr. Soros presumably did. In fact, a lot of good things happened. U.S. companies became more competitive, and exports are now booming. Profits from overseas operations and returns on international investments are soaring as the gains are translated back into dollars.

Long-term interest rates are still low, stock prices are setting records, and the economy continues to grow at a moderate clip. But dollar worries are cropping up again. Through much of the fourth quarter, the greenback was undermined by perceptions in many areas of the foreign exchange markets that the U.S. economy is slowing down sharply enough to warrant the Federal Reserve to begin cutting interest rates sometime in 2007, and most analysts expect the dollar to continue to weaken at least gradually in the coming year. The worst-case scenario would be a rapid decline that would disrupt global capital flows, damage foreign economies, push up U.S. inflation via higher import prices, and generally complicate the Fed’s job of managing the economy and the financial markets. However, that seems unlikely. In fact, the potential pluses from a further downward drift in the greenback will most likely continue to outweigh any minuses—to the benefit of both investors and the economy (“Why,” 2007).

Conclusion

Fortunately, the decline of the U.S. dollar is expected to help rather than hurt the most popular economy of the world.  Mann writes that policymakers around the world would inhibit the U.S. dollar’s move towards broad-based depreciation, or a fatal collapse, because the dollar acts as a principal economic component in “global co-dependency.”  The United States acts as a significant business leader in the world economy, and so, even when it is not financially wise to invest in the dollar as compared to the Euro – policymakers around the world would be willing to protect the dollar against a collapse by making it easier for people to invest in the U.S. dollar.

The world economy cannot envision itself functioning without the support of the United States’ economy.  Indeed, the U.S. forms a substantial market for foreign goods and services.  Should the U.S. dollar continue declining in value, the countries that export to the United States would find it difficult to carry out their businesses, given that their goods and services would become more expensive to American consumers in the face of the depreciated dollar.  Hence, policymakers around the world would continue to try to attract investment in the U.S. dollar, seeing that their interest in the U.S. economy is great.

     The declining value of the dollar has made it cheaper for foreign nations to import U.S. goods and services.  An increase in exports is essential for the United States to balance its current account – presently facing a deficit.  Moreover, consumers in the United States, including the government, are required in the process to reduce their spending so that the current account deficit can be eliminated.  This has not happened as yet.  However, the declining value of the dollar may also ensure that Americans would eventually begin to spend less on imports.

     The depreciated dollar is expected to raise the level of U.S. exports without giving birth to inflation.  This is because the Federal Reserve is not willing to allow the interest rates to increase by a substantial amount.  In point of fact, the low levels of interest rates make U.S. investments less attractive to foreign investors.  If the Federal Reserve would raise the level of interest rates, inflation may ensue.

     The present discussion has made it abundantly clear that the United States economy is not threatened by the declining value of the U.S. dollar.  Economists, in addition to the U.S. government, believe that this decline in value of the dollar would tackle the “long-range problem” facing the nation – that of the current account deficit and the trade deficit (Pace).  While there are many forces at work to balance the current account of the United States, the declining dollar seems to be one of the more important ones.  If the dollar starts to appreciate at this point in time, the United States would find it virtually impossible to balance its current account.  Hence, the decline in the value of the dollar truly is a blessing.

References

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     United States, are all locked into export-driven policies dependent on U.S. markets and

     competitively cheaper currencies. That’s why there are likely limits to dollar depreciation.

The Declining U.S. Dollar       12

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