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Causes of the Declining Dollar

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The US Dollar has been falling for the past 3-4 years. But, in 2007 the decline has seemed to increase. The 7 main reasons for the decline in the dollar are:

1. Lower US interest rates. The US has cut interest rates in 2007 by 0.75%, this is in contrast to the EU where interest rates have increased. Lower interest rates make it less attractive to save money in America compared to the rest of the world. Therefore, demand for dollar has fallen.

2. Sub prime crisis In America. The US has experienced a decline in the Housing market, with falling house prices and increasing numbers of mortgage defaults. This has done 2 things. Firstly, there is less confidence in the US economy and therefore less confidence in the dollar. Secondly, the fall in house prices has cause a slowdown in the economy. This has encouraged the Fed to Cut interest rates

3. US Current Account deficit. The US has a large trade deficit. This means the outflow of currency is less than the inflow. There is a strong downward pressure on the exchange rate when the current account deficit is high.

4. Market Confidence. With a falling dollar. Many investors are now feeling that the dollar is no longer a good investment. There is a growing feeling that the US dollar will lose its position as the world major reserve currency. This has caused investors to diversify out of the US dollar.

5. US Government Responses. Up until now. The US government has not sought to intervene. In a way it sees advantages from the devaluing dollar. It is helping to boost a faltering economy. A devaluation should help reduce the US current account deficit.

6. Strength of the Yuan. For many years the US, and others, have wished the Yuan to appreciate in value, to reflect its new status as a powerful currency. Slowly the Chinese government are allowing the Yuan to appreciate and better reflect local purchasing power parity.

7. Low savings Ratio - This is related to the current account deficit. Basically because American consumers are spending a high % of income (borrowing levels are very high) this is causing increased imports which leads to higher supply of dollars and therefore a fall in its value.

In 2008, the prospects for the dollar don't look much better. For more in depth analysis see: Forecast for US Dollar 2008


About the Author

Richard Pettinger studied Politics and Economics at Lady Margaret Hall, Oxford University. He now works as an economics teacher in Oxford. He enjoys writing essays on Economic and he edits an Economics Blog focused on UK and US economies: http://www.economicshelp.org/econ.html


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Article Published/Sorted/Amended on Scopulus 2008-02-22 11:57:12 in Economic Articles

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