Tuesday, October 16, 2007

The Fall of the Dollar

Above is the trade weighted value of the dollar against major currencies (major currency index includes the Euro Area, Canada, Japan, United Kingdom, Switzerland, Australia, and Sweden). Although the figure shows the dollar to have fallen significantly against the major currencies since 2002, many observers believe it has not hit bottom yet given the large U.S. current account deficits. Take a look at this graph to get a better sense of why a further fall in the dollar may be needed. The ongoing fall of the dollar is attracting much attention. Below are some interesting articles on this development.

A more competitive dollar is good for America, by Martin Feldstein, Commentary, Financial Times: The dollar has finally begun its long overdue correction. The dollar’s decline in recent weeks is just a prelude to the much more substantial fall needed to shrink the US current account deficit, running at a nearly $800bn annual rate, about 6 per cent of gross domestic product. If the dollar remained at its current level, the US trade deficit would continue to expand because Americans respond to rising incomes by increasing imports more rapidly than foreign buyers raise their imports from the US. Although a faster growth rate in the rest of the world would raise US exports and reduce the US trade deficit, experience shows that even substantially faster foreign growth would have only a very small impact. A lower dollar has to do most of the work of reducing the global trade imbalance. (Read the rest)

Triangular Trouble: the Euro, the Dollar and the Renminbi , by Thomas I. Palley: For the last several years the euro has been appreciating steadily against the U.S. dollar. Given the Chinese renminbi and other East Asian currencies are pegged to the dollar that means the euro has been appreciating steadily against all. This spells trouble for Euroland, and it suggests European policymakers should join with the U.S. to address the global problem of under-valued currencies. (Read the rest and see related article at the Economist: A Worker's Manifesto for China)

Is the United States headed for double bubble trouble?, by Richard Baldwin, Vox EU: In the minds of most mainstream international economists, there is never much doubt that the dollar must eventually decline significantly.[1] A trade deficit this big cannot persist indefinitely. Many analysts hope that the necessary real depreciation of the dollar might be gradual. After all, isn't the avoidance of such jumps one of the reasons we abandoned the Bretton Woods fixed-exchange system for a floating regime? So why are there modern fears of a sudden discrete drop in the dollar?

Here is the basic idea underlying dollar 'plunge scenarios.' Foreign investors have long demonstrated an increased appetite for US assets, moving a greater share of their portfolios into dollars and thus generating large capital flow into the US. But the capital flows needed to maintain an increased dollar share are much smaller than those needed to achieve it. Thus, when investors reach their desired holdings, there will be a drop off in capital flows into the United States, leading to an abrupt decline in both the current account deficit and the value of the dollar. (Read the Rest)

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