Monday, November 05, 2007

Is a Weak Dollar an Ailing Dollar?

The US Dollar is at an all-time low when compared with other commonly traded currencies. This is known as a weak dollar. It’s been trending steadily downward for over six years now, having lost some 30% of its value against key foreign currencies during that time.

Why has the dollar been so weak for six years? The CATO Institute’s Steve H. Hanke writes (here), “At present the Bush Administration's economic policies are perceived by most as being inconsistent, if not incoherent. Consequently, confidence in the dollar is low, and the greenback looks set to continue on its downward course. Indeed, once a currency starts to trend one way or another, it will continue to do so until it provokes a policy response.”

Hanke wrote that back in March of 2004, when the dollar was much stronger than it is today. Since that time, the dollar has continued its slide, confirming Hanke’s observation that a currency’s trend will continue until policy changes.

But a weak dollar is not all bad. ‘Weak’ tends to denote bad and ‘strong’ tends to denote good. But in fact, there are advantages and disadvantages to both a strong dollar and a weak dollar. A reasonable explanation of this can be found in this Federal Reserve Bank of Chicago essay.

Bear in mind that events over which the US has no control can have an impact on the value of the dollar. Many variables with complex relationships go into determining the value of a currency. The FRBoC essay lists a few of them about 60% of the way down the page linked above under the headings “Factors Contributing to a Strong Currency” and “Factors Contributing to a Weak Currency.”

A Sept. 14 post on Trader’s Narrative shows similarities between the dollar’s recent performance pattern and its pattern in the months leading up to Sept. 1992. The post shows how the dollar bounced off a low at that time and then significantly strengthened over the next year. The post discusses pattern similarities, comparing current performance of some noteworthy factors to what was happening 15 years ago.

While the Trader’s Narrative post says there is no guarantee that the future will mimic the past, the author writes that “right now everyone expects the dollar to crash as the Fed lowers rates. But things seldom occur the way everyone believes they should. Popular “logic” has a tendency to be ignored by the market.” In other words, he’s more bullish on the dollar’s future than the many bears out there.

Most Americans are blissfully unaware of the current state of the dollar on the international currency market. Those that travel abroad or that buy products from countries with comparatively strong currencies feel the pinch. Their dollars buy less of these goods and services than they used to. But the vast majority of Americans do not fit in this category, so they go on their merry way, rather unconcerned.

This Smart Money article explains how the current weak dollar actually helps many shoppers. This NPR article discusses how the weak dollar is impacting different people in the US. Americans buy a lot of foreign goods. But most of these goods come from China. China’s currency is fairly closely tied to the dollar, so most Americans don’t feel much pain from the steadily weakening dollar.

US economic policies will undoubtedly shift after a new administration comes to power in a little over 14 months, regardless of who wins the election. If those shifts combine with other world events to result in a strengthening dollar, there will be both positive and negative impacts.

Many have painted the weak dollar as a sign that the US is hurriedly heading somewhere hot in a handbag. But reality is actually far more nuanced than such a grim estimate suggests. A weak currency may, but does not necessarily indicate an ailing currency.


Jesse Harris said...

We're leaving for Italy in less than a week and do not savor the low exchange rate at all.

Scott Hinrichs said...

I'm sorry that the current weak dollar is going to make your trip far more expensive than it would have been a few years ago. On the other hand, the number of Europeans vacationing in the US is up due to the exchange rate.

Despite the high cost, I hope you have a great trip.