The great decline of the US dollar may not be over, but a slowing in the past week does hint at some limits to the free fall.
If the value of the dollar stabilizes, it would be welcome news for Americans worried about inflation – that their money isn't going as far when purchasing imported green grapes or gasoline. It would also offer comfort to other nations that are having a harder time selling exports to US consumers.
Since 2002, the dollar has been on a downward track. It's now at or near 35-year lows as measured by some indexes that represent baskets of other currencies. Last week, the dollar hit a record low against the euro, with $1.59 required to buy each unit of the European Union's currency.
In recent days, though, some signs of a dollar panic have abated. The greenback bounced back a bit against the euro. The price of gold – a metal seen as a haven in times of dollar distress – has plunged since mid-March.
What changed? The Federal Reserve indicated renewed vigilance against inflation, for one. The Fed's recent actions to shore up financial markets, too, seem to have calmed fears of chaos. On the heels of those steps, currency traders may have started wondering if their bearish bets against the greenback are running out of steam.
"I don't see a lot of downward pressures" continuing, says Nariman Behravesh, chief economist at Global Insight, an economic forecasting firm in Lexington, Mass. "Assuming that the economy recovers … we will not be looking at a dollar that will continue to weaken."
That forecast looks out over several years, but in the near term it's possible the greenback could set new record lows.
On Tuesday, for instance, news of declining US consumer confidence was one factor driving the dollar down against the euro, but in morning trading the value stood at about $1.56, still a bit stronger than last week's lows.
A weakening dollar can be a mixed blessing for the US and its trading partners.
To many economists, the strength of the dollar is a gauge of confidence in the US economy. And when the value of the dollar rises, it makes it easier for Americans to buy everything from oil to vacations in Europe.
"With the dollar rising all of a sudden, and commodity prices plunging, this would be a great time for the Treasury to get out there and buy dollars," New York economist Lawrence Kudlow wrote to clients last week. "Send a clear statement that the U.S. wants a stronger dollar. It would do a lot to reduce inflation expectations. And it would drive gold prices down $200 from here."
But many other economists, while they don't necessarily want the dollar to keep plunging, see a positive side to its recent weakness.
By making it cheaper for American companies to export goods, and harder for American consumers to import, it's serving to recalibrate a global economy that had grown too dependent on a US spending spree.
"The reality is that a weak dollar is doing a lot more good than harm to the US economy," Mr. Behravesh says.
Over the past year, for instance, the mammoth US trade deficit – the amount by which imports exceed exports – has begun to narrow. Such imbalances are not always a problem, but the US trade gap has been particularly large and persistent.
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.