As stocks, gold and even junk bonds soared in 2009 and the economy began to recover, one pillar of the US financial system got weaker — the dollar. By November, it had reached a 15-month low against a number of other major currencies. Despite an uptick in December, the dollar lost 8% of its value in 2009 through December 11 and 33% since 2002.
How much does that weakness matter to you as a consumer and an investor? And is there much that the US can — or should — do about it?
To shed light on what the weak dollar means for readers, Bottom Line/Personal interviewed Harvard professor and former International Monetary Fund economist Kenneth Rogoff…
Does the weakness of the dollar affect the average American’s life on a daily basis? It does. And in many ways that go beyond the obvious, such as the sticker shock you get when planning a vacation to Paris or Rio. For instance, a weak dollar makes imported products much pricier to buy here. Many products are getting more expensive in the US, including Italian olive oils, French wines and Japanese cameras. The falling dollar also is fueling speculation among investors in commodities, including crude oil and wheat, which drives up prices of gasoline and bread.
Why has the dollar gotten so weak over the past several months? Foreign investors are worried that we can’t keep our fiscal house in order, due to our ballooning federal budget deficit… fears of inflation that have risen because of excessive government spending… and expectations of continued US trade deficits, which the US is paying for by borrowing from the rest of the world. Another force undermining the dollar is the measures that we have taken to stimulate the weak US economy by reducing our short-term interest rates to near zero. Investors are borrowing dollars cheaply, then speculating by selling them to buy currencies of countries where they think that stocks and bonds promise better returns.
Are there any benefits of a weak dollar? Yes. By making American products cheaper for most foreign buyers, the dollar is helping many US companies boost their overseas sales. The weakening dollar also gives domestic businesses a competitive edge at home, making their products cheaper than rival imports and increasing tourism here as more foreigners can afford to visit and spend money in the US.
The Federal Reserve and the White House would never put it this way, but they welcome the weak dollar now because it helps stimulate the economy.
If the dollar continues to weaken, what’s the worst-case scenario? Foreign powers could decide that they’re tired of financing our current deficit by investing in US government assets, in which case they would demand a lower price for our bonds and a higher yield to invest in dollars. That could lead to a sharp plunge in the value of the dollar, perhaps a 25% drop against the world’s other major currencies over a few months. A panicky sell-off of dollars would make it even harder for us to pay down our national debt and would increase our risk for another long, deep recession.
Despite much saber rattling from China about that possibility, though, I think it’s unlikely. China currently owns a trillion dollars’ worth of US government bonds. The collapse of the dollar would be economically catastrophic for China as well. The underlying dynamics of the US economy and the diversity and depth of US financial markets will generate a demand for dollars for many decades. It’s still the most used currency for international transactions and constitutes more than 60% of other countries’ official foreign-exchange reserves. During the global meltdown last year, for instance, many people around the world jumped into US Treasury securities even though the US economy was among those being battered.
What do you think will happen to the dollar in the future? It will continue its long, very slow slide against other currencies, with periodic rallies during times of world crisis, for the rest of our lifetimes. The long-term worry for our children and grandchildren is that the dollar will lose its central role in world financial markets. But with sound fiscal and monetary policy, the US dollar might slow down its slide considerably.
