The Buck Stops Here- Or Does It?

Written by Dr. Lynn Reaser, PLNU Chief Economist

The U.S. dollar has fallen 8% during the past six months while gold prices have soared.  What has caused the greenback to slide, who will be impacted, and what is the outlook?

The dollar peaked early in 2002 and has trended lower over the last several years.  This was the market’s response to a large trade and current account deficit.  By making exports more competitive and imports more expensive, this corrective process has helped to shrink deficits from their previous highs.  The dollar did rise briefly last year as anxious investors sought the safest asset in the world—short-term U.S. Treasury bills.  Emerging confidence in an economic recovery and the move of investors into riskier stocks and bonds has helped push the greenback lower again in 2009.

Is a weak dollar good or bad?  It depends where you stand.  Exporters benefit from a cheaper dollar as do multinational firms, who account for more than half of the profits of the S&P 500 firms.  Companies like Procter and Gamble or Coca Cola gain as their earnings from abroad are translated back into dollars.  U.S. investors who invest in foreign stocks, bonds, or mutual funds also win as their overseas gains buy more dollars when they are brought home.  In contrast, tourists traveling abroad will find it more expense and U.S. consumers could see higher prices for some imported goods.

Foreign investors now hold slightly more than half of our Treasury debt.  While there is little risk that they would sell large amounts of our debt because of the possible damage to their own portfolios, higher interest rates and a weaker dollar may be necessary to coax continued foreign financing of our budget deficit.  A precipitous slide in the dollar’s value does not appear likely, but further weakness can be expected.


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