The Demise of the Dollar

It was the best of times, it was the worst of times. Such is the story of the US economy. Today's news concerns the continued downward spiral of the dollar, detailed exquisitely in The Financial Times. To many, this sounds pretty bad and when you see this graph, it looks like a disaster. Oddly, stocks are generally up, though they seem to have corrected downward on the fall of the dollar.

Still there are a lot of questions to be answered if one is going to push the gloom and doom side of the story. Like, why is the trade balance still in deficit? A falling currency is supposed to make exports cheaper, n'est-ce pas, and lead to a correction. A dropping value is also supposed to indicate inflation and interest rates are supposed to soar. Inflation seems to be low. There are many indications that the Fed is going to drop interest rates next year! How can the Euro increase 50% in value to the dollar without us seeing any appreciable indication?

One probable reason is the import imbalance with the Chinese. If Exports and Currency Value are inversely related, holding one low will raise the other and right now, the Chinese are doing exactly that. They rather peg their currency and do not allow the market to dictate the exchange rate. This artifically increases imports from China. The Chinese put the payments in the US financial system which works to keep interest rates low. As I've stated below, this does little good for the Chinese. In 2003, they were holding about half a trillion dollars in account balance. Right now, they've lost about 20% of that in real value. Should they decide to sell dollars, they'll lose even more.

The recent correction with the Euro is most likely due to lower oil prices. Many believe that the Europeans are set to see expansion next year and lower gas prices will help economies already burdened with high fuel costs.