Investors continue to show signs of worry about the depreciation of the US dollar. The decline in value means that US exports are cheaper for foreign businesses driving up risk and competition for US businesses. As a result of this fear shown by the plummeting volume of trade in financial markets, American businesses are increasingly withdrawing capital spending.
US currency has been facing a downward spiral since 2002. Although Americans, collectively, continued to spend more than the income generated investors and lenders became more risk averse towards investing. Feelings about the dollar reached reality TV stardom when in 2005 Saturday Night Live parodied the currency in a skit titled, “The Not Incredible Adventures of the Down and Out Dollar.”
As seen through the eyes of the investment world; for the first time in US economic history, the dollar’s perceptional reign is over.
Or, is it?
While reports continue to surface about the devaluation, more often than not, its comparison is made against the Euro currency. Since its formulation on January 1, 1999, the euro has remained the US’ most competitive rival. The battle for currency dominance reached new heights for the United States when- for the first time- its financial composition on official and private (reserves) assets held by foreign governments, businesses and investors was challenged. In 2006, the Bank for International Settlements, a conglomerate of global central banks, reported that from 1999-2002 the US accounted for 63% of total foreign reserve assets and that euro currency accounted for 26% total foreign reserves. Subsequently, from 2003-05 the United States descended to 59% of reserves while the “Euro” increased to 31%. Albeit not a tremendous loss, this shift, however, signified not a loss of confidence in US currency rather a gradual change in the role of leadership.
Additionally, with investment indices reporting that the US dollar declined against the euro by 40% (and the Canadian dollar by 30%) from 2002-2008 it would seem to be troubling news. Well, in actuality, the gap in decline is only in relation to its biggest competitor; against the “basket” of currencies, the dollar had only decreased by 14% – a stark contrast to 40.
More evidence to support, that when compared against the major basket of currencies, the decline is not as bad as it seem. In fact, some economists argue that the dollar should decline further in order to help reduce the trade deficit. “Since reducing the trade deficit requires increasing exports and shrinking imports, the international value of the dollar must decline to make US products more attractive to foreign buyers and US goods and services more attractive to American consumers,” claimed renowned Harvard University Economist Martin Feldstein.
Josh Bivens of the Economic Policy Institute, a non-profit Washington D.C. think tank, concluded that, “The benefits of the lower value of the dollar will be felt predominantly in the manufacturing sector, as it accounts for more than 80% of traded goods in the United States. This means that the positive effects of the falling dollar are concentrated in the sector that has suffered most in the recent recession.”
Added to this notion of a weaker dollar having positive effects on the overall economy, by first attacking its sectors, is Jim Cramer of CNBC’s “Mad Money w/Jim Cramer.” He stated in 2009 that “a weak dollar will help the US “crush” global competitors,” because foreign companies “will lose out to “cheaper” American businesses,” especially to those companies in the construction industry where economic vitality is crucial to employment recovery.
The current trend for investors may be to fret over the depreciating dollar, but, what needs to be kept in mind instead is the more crucial- in terms of value- rate of inflation. Inflation is typically defined as, “the overall general upward price movement of goods and services in an economy.” This definition is accurate but misleading. Many have argued that the declining value of the dollar has a direct impact on the appreciation of inflation. This is not so. Inflation does not have a direct cause/effect relationship with the price of currency; it has merely a causal correlation between the two. One such finding by R.W. Hafer of the Federal Reserve Bank of St. Louis (1989) declared that, “since economic theory suggests that exchange rates are forward-looking, reflecting market expectations, a finding that exchange rate movements appear to statistically “cause” inflation is merely an indication that they respond faster to changes in the relative economic conditions than do observed price levels.”
Another point to note is that the Federal Reserve (or Feds) -which regulates monetary policies involving interest rates and inflation- has managed to keep the rate of inflation under 2 percent; as of October 2010, the current rate is 1.17 percent. So, agree with their policies or not, the Feds has kept inflation under control since the start of the recession.
[I highly encourage you to read “Does Dollar Depreciation Cause Inflation” (R.W. Hafer)]
In the meantime, American and foreign investors alike continue to use caution against the weaker dollar with foreign investors-in particular- becoming less likely to purchase US securities (such as Treasury bonds) without the Feds increasing interests rates in order to cover the perceptual risk. However, this action is not likely to occur due to US Treasury Secretary Timothy F. Geithner announcing in early February 2010 that the US will “never” lose its AAA debt rating (Bloomberg, Feb. 8, 2010).
So as it goes: Investors are watching the dollar’s decline in US financial markets; as a result of investors moving their money to foreign markets, US businesses are holding back on their capital/investment spending stifling economic growth.
The perception does not reflect the broader economic scope. Just as certain economic sectors are cyclical, so are investment trends. If investors want the US dollar to rise again to its former glory, then they must simply invest again in US businesses.
- FOREX-Euro near 2-mth low, focus on Portugal, Spain (reuters.com)
- Growth currencies look shaky (financialpost.com)