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| From Japan: Shigeru Mushiaki and Kiyoshi Muraoka (r.) said a weak dollar allows them to spend more in Boston. mark thomson |
Signs the U.S. dollar free fall is ending
The greenback has bounced back a bit after hitting a record low against the euro last week.
from the March 26, 2008 edition
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In effect, foreign nations have been happy to loan America money, but that puts America in a vulnerable position if those nations become less willing to lend in the future.
To the degree that other economies rely on exports to the US, the large imbalances make them vulnerable if US consumers at some point can't afford to buy.
While the trade gap remains large, it's suddenly moving in a positive direction.
"The happiest company in America right now is GM," says David Hale, who heads Hale Advisers, an economic consulting firm in Chicago. The yen's rise against the dollar "will hit the profit margins of Toyota and all the Japanese exporters."
The dollar's decline has been driven by a number of factors. Just as weak growth in European economies hurt the euro in the late 1990s, the US has become the current weak spot in the global economy. Many economists say America is in recession, with consumers struggling in the aftermath of a housing boom and bust.
Related uncertainty about the health of US financial firms has also weighed heavily on the greenback.
Moreover, inflation for years has been higher in the US than in Europe. With the Federal Reserve cutting interest rates to spur the economy, the "real" short-term return for investors holding dollars is negative.
The Federal Reserve's latest moves have given pause to the bearish trades in US currency.
Last week, the Fed cut short-term interest rates again, but accompanied the move with a statement that it remains concerned about inflation – and not just about a cooling economy. And the Fed's move to prevent a bankruptcy at the investment house Bear Stearns reassured investors that mortgage-related losses won't result in a total meltdown of the banking system.
Another glimmer of hope: A modest rise in home sales, for the month of February, suggests that as US home prices fall buyers will return to the beleaguered housing market.
All this suggests that the tough financial times for America – and the dollar – won't last forever. "I'd say we're just going to be in a trading range" for a while, says Mr. Hale. But "the dollar still has a bias on the downside."
Is there a risk foreign investors will become frustrated about holding dollars for the long term? To some extent, that's already been happening as some nations sever the formal links that have long tied their own currencies to the dollar. Even Saudi Arabia worries about rising inflation because of its link to the dollar.
US policymakers can't afford to ignore these risks. Inflation and federal budget deficits will have to be held under control to avoid a continued dollar decline. But analysts say that foreign aversion to the dollar has limits.
The US economy is so big, and foreign nations hold so many dollars, that a policy of dumping the dollar would hurt everyone. "The dollar is still the dominant reserve currency and I think it will be … for many years," says Hale.
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