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The Falling Dollar
Umberto Bifulco, IV
Introduction
The United States began as a fragile nation, economically. Through the passage
of time it has become an economic powerhouse, built on the pillars of a free market
economy. U.S. economic policy has shaped global currency markets and contributed to
the strength of the U.S. economy. However, recent developments in the global economy
put pressure on U.S. currency and have forced a weakened U.S. Dollar to compete
against foreign currencies. Up until recently, the U.S. Dollar was falling in value and we,
as a nation, must recognize the problems that could develop as a result.
The following questions act as a basis for a discussion on U.S. Economic Policy
and the issue of a weak dollar. The thesis of this discussion is two pronged. First, an
assessment of the current situation, its causes and implications, is necessary. Second, an
analysis is necessary to isolate what circumstances need to be in place, in order for the
US Dollar to fully rebound. This analysis must include the government’s involvement in
the currency value issue and the Federal Reserve System’s policy approach must be
explored. Finally, the following questions are raised and answers suggested to further
clarify the topic. Why does the decline of the Dollar matter and to what degree should
policy makers be involved in attempts to correct the problem?
Factors Contributing to the Weakening Dollar
A decline in value of the Dollar may be viewed as an increase in the number of
Dollars that must be exchanged for another currency, or conversely, a decrease in the
number of units of a foreign currency that must be exchanged for a U.S. Dollar.
Exchange rates between the Dollar and other currencies are expressed to reflect these
relative values [see appendix A for current rates and Appendix B for historical rates].
While the value of the dollar has increased in recent history relative to other major
currencies, its long decline has not been entirely counteracted, not have the reasons for its
decline up until recently been reversed.
There are a variety of explanations offered for the decrease in value of the U.S.
Dollar internationally. A major reason often cited is the increase in U.S. government
debt. “The largest buyers of U.S. government debt have been the central banks of the
Asia-Pacific. The central banks of Japan and China alone hold more than $1 trillion of
U.S. Treasury bonds as foreign currency reserves. Worldwide foreign central banks hold
some $1.3 trillion of U.S. government debt. If private debt is added, the United States is
the world's largest debtor nation, with some $3.7 trillion in net foreign debt, as of the start
of this year, likely well over $4 trillions by now” (Is a USA Economic Collapse Due in
2005?, 2004).
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Another frequently cited cause is the ongoing current account deficit, or excess of
imports over exports (Baumol et al, 2005). In a recent news release, the U. S. Bureau of
Economic Analysis announced that the November 2005 deficit in goods and services
totalled $64.2 billion, up $5.2 billion from one year earlier (News Release: U. S.
International Trade in Goods & Services, 2006). “Other countries’ economies benefit
from sending their goods to eager American buyers, and the United States in turn sends
massive amounts of dollars abroad to pay for those goods. The trouble is that there are
now more dollars than foreigners want to hold….So when surplus dollars are sold for
Euros, Yen or Pounds, then the dollar drops in value against those currencies”
(Samuelson, 2005).
Other factors include the value of other assets available to foreign nations other
than the dollar, the March 2000 collapse of the dotcom market, the September 11 terrorist
attacks in 2001, and how consumer confidence was affected by the war in Iraq (Why is
the US Dollar Weakening? Internal and external factors combined to drive the American
dollar down in 2003, 2003). In addition, factors such as the successful creation of the
European Union (EU) and the European Monetary Union (EMU), the emergence of
China as an economic power to be reckoned with, and the stock market scandals caused
by Enron, WorldCom, and the fall of Arthur Anderson which lead to a change in
accounting policy for corporations and set new standards of accountability to senior
management, all have impacted U.S. trade and the value of the dollar.
These factors all influence investor confidence and desirability of U.S. goods and
investments. The lack of desirability of U.S. production and investments, combined with
the existence of alternative sources of goods and investments, mean that demand for
dollars to purchase in the U.S. declines and must negatively influence the value of the
Dollar relative to other currencies (Melvin, 2004).
Options for Strengthening the Dollar
Economic theory suggests that a decline in the value of a currency should
promote interest in a nation’s exports as those exports become relatively cheaper for
foreigners to buy. At the same time, imports become more expensive causing U.S.
consumers to buy domestic production instead. In this way, a declining currency will
rebound of its own accord, requiring no intervention (Mishkin, 2004).
Additionally, international investors should be attracted to investments
denominated in dollars as their native currencies will buy larger shares of those
investments, though as will be seen, there is risk associated with investment in securities
denominated in a currency that continues to decline. Evidence, as seen in the appendices
regarding the continued decline in the value of the dollar, gives rise to some concern that
letting the market system work is not having the desired effect. Also, contributing factors
such as increased outsourcing of production, an increasing federal debt, and the ongoing
and generally growing trade deficit, may offset any market forces that put upward
pressure on the value of the dollar.
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Should some policy intervention be considered, the value of the dollar can
theoretically be influenced by both the Federal Reserve System (Fed) and the Federal
Government. The Fed manages what is known as the monetary base but money is
expanded and contracted by lending and borrowing between the public and the banking
sector. Interest rates are inversely related to the volume of money in circulation, and
while the Fed may target rates, currently targeting the Federal Funds Rate, interest rates
are subject to many influences and complete control is not possible (Mishkin 2004).
The Fed also holds foreign currencies and can influence the value of the dollar
internationally by buying and selling those currencies, but follows a policy of freely
floating exchange rates for the most part. Central Banks around the world, acting in
conjunction with their respective governments, may cooperate with each other to
maintain the value of different currencies including the dollar, again by buying those
currencies currently experiencing a decline in value (Melvin, 2004). The Fed conducts its
operations based on its monetary policy objectives and with the goals of the Federal
government in mind. With respect to its exchange rate actions, as Melvin notes, “the role
of various central banks is to conduct foreign exchange operations for central
governments” (2004).
The Executive and Legislative Branches of the government have influence over
trade, through legislation and treaties enacted with trading partners. Current emphasis in
trade policy is to extend trade free zones to encourage U.S. exports, though experience
with the North American Free Trade Agreement (NAFTA) indicates that such treaties
and agreements may as easily encourage imports as exports.
The President has no true power beyond influencing morale and offering
encouragement regarding the strength of the U.S. economy and the currency (Burns et al,
2004). In addition, the President may actively campaign for trade agreements under
consideration. That such campaigning does occur indicates that the Federal Government
does have some concerns regarding the issue of U.S. trade and international financial
standing.
Why the Decline Matters
One of the problems created by this value decline occurs when U.S. companies
want to buy foreign goods, products, services, or raw materials they need to spend more
money to buy the same volume of goods and services. Many U.S. companies outsource at
least part of their production today, generally to lower production costs. The benefit
should be a decrease in prices of goods for U.S. consumers. A devalued dollar, however,
reduces these cost savings for U.S. producers and consumers do not see the lower prices
that they might have with a stronger dollar. Further, much of what Americans buy is in
fact imported, as evidenced by the trade deficit. Prices for imports must also rise with the
decline in the value of the dollar. Even domestic travelers going abroad need to spend
more U.S. Dollars to buy the foreign currency of locations visited because the U.S. dollar
does not have the buying power it did years ago.
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This also matters, because as noted, fewer foreign investors may choose the
United States as their preferred place of investment, putting further downward pressure o
the value of the dollar. International investors, seeing a continued decline in the U.S.
Dollar understand that such a decline, should it continue, puts at risk their investment
gains. Given the increased availability of investment alternatives, either U.S. investments
must offer higher rates of return or lose the invested capital that comes from abroad.
Lack of investment from abroad can have not only an adverse affect on the future value
of the dollar, but also on domestic unemployment, inflation, and Gross Domestic Product
(Melvin, 2004).
“A recent survey by Central Banking Publications of 65 central banks… found
that two thirds are moving away from dollars toward euros. Private investors could also
desert the dollar,” and thus, our rank will fall in the global market place (Samuelson,
2005). So this begs the question for the future, could oil prices which are now set in
Dollars, be set in Euro. Even with the recent difficulties for the Euro, the United States is
no longer seen as the only safe haven for investors. The number of nations participating
in the single currency is large now, and will potentially grow larger. [See Appendix C]
Conclusion
In conclusion, some concern must be felt regarding the value of the Dollar and its
decline’s impact on the U.S. economy. Many Americans believe that the U.S. economy is
impervious to crises that befall other nations and are inclined to view the declining value
of the dollar as a minor inconvenience with no potential for creating larger problems.
Others perceive that, while a problem, it is the nature of a free market system to
correct problems like a depreciated dollar without intervention by government or
monetary authorities. Still others believe that our international troubles stem from other
nations, rather than our own practices. The first step of solving any problem, however, is
admitting there is one, and it is not other nations that should be blamed. Rather, it is our
lack of an adaptive response to big emerging markets such as the EU, India or China, and
our own habits of exporting production and choosing to import so much of what we
consume, as well as our reliance on foreign sources of energy, which seems to promote
the greatest threat. Minimally, the decline of the dollar should be acknowledged and
treated with the same attention that is accorded to the threat of terrorism.
Furthermore, because the government derives its power from its economy, it is
vital for the security and well being of the American people and the further development
of our nation. Everything comes from the economy; jobs, military spending,
infrastructure. It is essential for American as a whole to spur the economy in order to
insure a quality standard of living and provide a safety net for future generations to come.
The U.S. needs a better assessment of where it presently stands internationally in terms of
its economic well-being, and should develop a strategy to better protect U.S. jobs, Gross
Domestic Product, and the Dollar.
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References
Baumol, W., & Blinder, A. (2005). Macroeconomics: principles and policy. 10th ed.
Mason,Ohio: Thompson Learning; South-Western.
Burns, J.M., et al. (2004). Government by the people. Upper Saddle River, NJ: Pearson;
Prentice Hall.
Canadian Centre for Cyber Citizenship, (2003). Why is the us dollar weakening? internal
and external factors combined to drive the american dollar down in 2003.
Retrieved March 30, 2005, from MapleLeafWeb Web site:
www.mapleleafweb.com/features/economy/loonie_rebounds/american.html.
European Central Bank, (n.d.). The euro area. Retrieved Jan. 23, 2006, from European
Central Bank Web site: www.ecb.int/bc/intro/html/map.en.html.
Federal Reserve Bank of St. Louis, (2006). U.s./euro foreign exchange rate. Retrieved
Jan. 22, 2006, from FRED® II Web site:
http://research.stlouisfed.org/fred2/data/EXUSEU.txt.
Is a usa economic collapse due in 2005?. (2004). Retrieved March 16, 2005, from
Ballotpaper.org Web site: www.ballotpaper.org/archives/000568.html.
Melvin, M. (2004). International money and finance. 7th ed. Boston: Pearson; AddisonWesley.
Mishkin, F. (2004). The economics of money, banking, and financial markets. 7th ed.
Boston: Pearson;Addison-Wesley.
Samuelson, R. (2005). Bottom dollar. Newsweek, March 31, 38-48.
U.S. Bureau of Economic Analysis, (2006). News release: u.s. international trade in
goods & services. Retrieved Jan. 22, 2006, from BEA News Web site:
www.bea.doc.gov/bea/newsrel/tradnewsrelease.htm.
Yahoo! Finance, (2006). Euro to u.s. dollar exchange rate. Retrieved Jan. 22, 2006, from
Yahoo! Finance Currency Converter Web site:
http://finance.yahoo.com/currency/convert?amt=1&from=EUR&to=USD&submit
=Convert. .
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Appendix A
Value of US Dollar: Euros per Dollar
Note: Exchange rate represented as Euros per Dollar. This graph depicts how the value
of the Dollar is generally in decline against the Euro, at least up to November 2005.
(Euro to U.S. Dollar Exchange Rate, 2006)
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Appendix B
Title:
Series ID:
Source:
Release:
Seasonal Adjustment:
Frequency:
Units:
Date Range:
DATE
VALUE
2002-12-01
2003-01-01
2003-02-01
2003-03-01
2003-04-01
2003-05-01
2003-06-01
2003-07-01
2003-08-01
2003-09-01
2003-10-01
2003-11-01
2003-12-01
2004-01-01
2004-02-01
2004-03-01
2004-04-01
2004-05-01
2004-06-01
2004-07-01
2004-08-01
2004-09-01
2004-10-01
2004-11-01
2004-12-01
2005-01-01
2005-02-01
2005-03-01
2005-04-01
2005-05-01
2005-06-01
2005-07-01
2005-08-01
2005-09-01
2005-10-01
2005-11-01
2005-12-01
1.0194
1.0622
1.0785
1.0797
1.0862
1.1556
1.1674
1.1365
1.1155
1.1267
1.1714
1.1710
1.2298
1.2638
1.2640
1.2261
1.1989
1.2000
1.2146
1.2266
1.2191
1.2224
1.2507
1.2997
1.3406
1.3123
1.3013
1.3185
1.2943
1.2697
1.2155
1.2041
1.2295
1.2234
1.2022
1.1789
1.1861
U.S. / Euro Foreign Exchange Rate
EXUSEU
Board of Governors of the Federal Reserve System
G.5 Foreign Exchange Rates
Not Applicable
Monthly
U.S. Dollars to One Euro
2002-12-01 to 2005-12-01
(U.S./Euro Foreign Exchange Rate, 2006)
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Appendix C
The euro area: Participating countries
12 Member States of the European Union are participating in the
single currency:
•
•
•
•
•
•
Belgium
Germany
Greece
Spain
France
Ireland
•
•
•
•
•
•
Italy
Luxembourg
The Netherlands
Austria
Portugal
Finland
Non-participants:
Czech Republic, Denmark, Estonia, Cyprus, Latvia, Lithuania, Hungary, Malta, Poland,
Slovenia, Slovakia, Sweden and the United Kingdom are members of the EU but are not
currently participating in the single currency. Denmark, Estonia, Cyprus, Latvia,
Lithuania, Malta, Slovenia and Slovakia are members of the exchange rate mechanism II
(ERM II). This means that the Danish krone, the Estonian kroon, the Cyprus pound, the
Latvian lats, the Lithuanian litas, the Maltese lira, the Slovenian tolar and the Slovak
koruna are linked to the euro. It is expected that in the future more countries will join
ERM II.
(The euro area, n.d.)