Is the Dollar Doomed to Keep Falling
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Since 2001 the dollar has been in steady decline. Against the £ the dollar
has fallen from a low of £1 = $1.45 to close to the £1 = $2 mark. Against the
Euro the $ has also depreciated from 0.85 to the present level of 1 Euro to
From several perspectives the fall in the value of the dollar appears to be
following basic economic fundamentals and whilst these imbalance continue the
dollar may continue to fall.
Firstly the US current account deficit is remaining at record levels. The
exact amount of debt with the rest of the world is predicted to be around $710
billion for 2006  Basically this means America is importing more than it is
exporting, causing an outflow of money. In recent years this huge level of debt
has been bought by countries like Asia who have been happy to buy into the
dollar for its perceived status as a “stable and secure” currency. However there
is increasing evidence Asian bankers are no longer so confident in the American
economy. Thus they are seeking to divest from the dollar and reduce their dollar
holdings. As this occurs the dollar will have to fall as there is insufficient
buyers of American debt.
Secondly the future for economic growth is no longer looking so positive.
Growth forecasts have recently been downgraded. The OECD has downgraded is
growth forecasts for the US economy from 3.6% to 2.4%. Pessimists such as
Nouriel Roubini, of Roubini Global Economics  are predicting a recession in
the US by the middle of 2007. An important factor in declining growth forecasts
is the falling US consumer confidence.
Related to this is a signal that the previous ebullient housing market may
have at last turned the corner. Whilst new house prices continue to rise. The
median price of old houses have fallen by 3.5% since last year. Whilst a fall of
3.5% may not sound that much, it is the biggest on record. Also rising house
prices have been a key factor in maintaining consumer spending in recent years.
The level of personal debt amongst US consumers is at another all time high. The
ratio of consumer debt to disposable income has risen from 62% in 1980 to 127%
in 2005 
Thus a fall in house prices will have a powerful knock on effect on the rest
of the US economy as consumers struggle to refinance and meet levels of debt.
Another consequence of this high level of consumer debt is that the US economy
will be particularly sensitive to any rise in interest rates. Higher interest
rates would be one solution to a falling currency and may be necessary to
attract investors to finance America’s trade deficit. Although the prospect of
the Fed raising interest rates is remote at the moment. Continued falls in
American dollars would cause a rise in the long term interest rates on American
However some economists argue that prospects for the
dollar may not be as bad as some predict. Firstly as Anatole Kaletsky argues
 in an era of globalisation and deregulated financial markets, trade deficits
are not as difficult to finance as they used to be. Empirical evidence suggests
that trade deficits are very unreliable as a guide to exchange rate movements.
Firstly one of the few countries with a current account surplus is Japan. Their
current account surplus has been growing and yet the Yen is one of the few
currencies to have fallen against the dollar. 
Secondly although American growth is slowing at the moment it is not doing
much worse than the EU and Japan economies. The gap in interest rates between
the 2 economic areas is still only about 2%. If there are good reasons for the
dollars weakness there are less good reasons for the strength of the EURO. Also
some American economists such as Ben Bernanke of the Federal reserve remain
optimistic about the state of the US economy arguing growth is only marginally
below trend rate.
However it is important not to underestimate the importance of general market
sentiment regarding the American economy. Political problems such as in Iraq
have to an extent undermined America’s standing as a leader of the World in both
an economic and political sense. For 50 years America has been the undisputed
global economic superpower, but slowly perceptions are changing that the era of
the dollar may becoming to an end. As people switch out of dollars it could
create a powerful multiplier effect as investment bankers are reluctant to hold
onto their dollar assets.
America to a large extent can’t avoid a period of adjustment as it seeks to
deal with its triple deficits, trade deficits with the rest of the world,
consumer debt, and US government debt. Whether the period of adjustment is
gradual or painful will depend upon 2 things. Firstly how significant will be
the fall in US house prices and consequent fall in consumer confidence. Secondly
it will depend on the attitude of Asian bankers, in particular the Chinese.
Since they hold so many $ assets they may try to manage a gradual devaluation, a
continuation of the past 5 years. However if the dollar does lose its status as
the reserve currency of the world, there could be a growing stampede as
America’s creditors seek to cash in their cheques. This would exacerbate the
fall of the dollar, causing real economic hardship for America and the rest of
The only thing for sure is that European consumers are likely to be get some
real bargains from shopping in America for the considerable future.
About the Author
R.Pettinger is an Economics teacher at Oxford and writes frequently on the UK
economy and mortgages. He edits a site about Mortgages including a guide to
different types of mortgages.
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Article Published/Sorted/Amended on Scopulus 2007-03-25 20:17:10 in Economic Articles