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Over the past several months, it has become increasingly fashionable to refer to the decline of the U.S. dollar as another financial “crisis.” Yet, given the current state of the global markets, declaring that the dollar’s recent losses amount to a “crisis” is an overstatement.
To the contrary, current conditions surrounding the dollar are arguably supportive of – if not integral to – economic recovery.
The fall of the dollar
In 2002, the dollar began a sustained, steady descent relative to many of the world’s major currencies. By the first half of 2008, it had fallen nearly 50% against the euro and 30% against the British pound. It had fallen approximately 15% against the Japanese yen.
The dollar’s multi-year, downward trend continued unabated until 2008, when the subprime crisis began to unfold and unprecedented volatility struck the financial markets. Given the widespread panic that ensued, investors from around the world abandoned other currencies in favor of the perceived safety of the dollar, the world’s reserve currency. As a result, the dollar achieved significant gains during this period of maximum uncertainty, as people around the world showed a newfound respect for its underlying, long-term strength. The Dollar Index, which measures the value of the dollar compared to a trade-weighted basket of currencies, gained approximately 25% between April 22, 2008 and March 5, 2009.
On March 9, 2009, however, the equity markets hit their bottom, and as investors became less fearful, the dollar again began to decline. From that date until the present, while the stock and bond markets produced consistent gains, the dollar steadily surrendered most (but not all) of its newfound gains. Since its March high, the Dollar Index has fallen approximately 16%, due, in all likelihood, to loose monetary policy (including abnormally low interest rates), dollar shorting, and an increased appetite for risk.
The implications of a weaker dollar
A substantially weaker dollar over the longer term would make imports more expensive and would likely lead to inflation. Commodities and oil prices, in particular, tend to rise as the dollar declines, and higher energy prices generally serve as an impediment to economic growth.
In today’s deflationary environment, however, the inflationary effects of a lower dollar have been offset by declining prices elsewhere in the economy. The housing sector, for example, is the largest component of the Consumer Price Index and it has been profoundly deflationary, thereby counteracting rising import prices. Indeed, with high unemployment rates, declining housing prices, and an oversupply of goods, the Consumer Price Index still remains down 0.2% from a year ago.
With the threat of inflation presently in check, the dollar’s decline has, in all likelihood, contributed to the recovery of the U.S. economy. A lower dollar means that U.S. exports are generally more affordable to foreign buyers. U.S. goods have become increasingly competitive in the global marketplace, and the U.S. trade deficit has been reduced.
The importance of U.S. exports becoming more competitive should not be understated. Over 30% of the earnings of all S&P 500 companies are derived from abroad, and accordingly, more competitive exports translate directly to higher earnings for corporate America. Higher earnings typically translate to higher employment, and higher employment typically leads to a stronger housing sector. Thus, the dollar’s decline has not been a “crisis,” but more likely a key driver in sustaining the current recovery.
Indeed, as is the case with any economic phenomenon, the dollar’s recent decline of approximately 16% must be considered in an appropriate historical context. The dollar has suffered far greater falls in the past without damaging the economy or otherwise creating any “crisis.” During the latter part of the 1980s, for example, the dollar declined by almost 40% relative to other major currencies, but it did not wreak havoc on the economy. In fact, on a trade-weighted basis, adjusted for inflation, the dollar was below its present levels twice in the 1970s, once in the 1990s, and once as recently as the beginning of 2008.
