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Economy Watch
Economy Watch follows the progress of the world economy and offers you our weekly picks. Be sure to visit for the weekly updates.
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October 29 Updates
| The falling dollar, will it collapse?
The 2008 financial crisis almost crashed the Americans and affected countries around the world. Following that, various regions are hit hard by natural calamities. Ironically, one of the few calamities that have not befallen the world economy during the recent years is a dollar crash.
Many economists had warned that foreigners, who are tired of America’s increasing external deficits, would send the greenback slumping and interest rates soaring. However, the opposite came true. The crisis began within America, and the deeper it sink, the greater the dollar strengthened as fearful investors sought safety in Treasury bills. Between September 2008 (period when Lehman Brothers fall) and March 2009 (America’s stockmarkets hit bottom), the dollar rose by almost 13% on a trade-weighted basis.
The fall of the Lehman Brothers is a history worth remembering when assessing the dollar’s future. For the past six months the greenback has been sliding steadily, hitting its lowest against the euro in the past week. The slide has rattled policymakers in economies whose currencies are rising (see next article). The weak dollar has also revived fears of a currency crash. With the budget deficit in double digits and the Federal Reserve’s balance-sheet swelling, it is forecasted that the slide could become a rout and spell the end of America’s status as the world’s reserve currency.
The fall of the dollar has been overblown. “It exaggerates the scale of the slide and misunderstands its cause. Much of the recent weakness simply reverses the earlier safe-haven flight to dollars, a sign of investors’ optimism about riskier assets rather than their fears about America’s currency. On a trade-weighted basis the dollar today is close to where it was before Lehman failed. Yields on Treasuries have not risen and spreads on riskier dollar assets continue to shrink. If investors were growing leerier of dollars, the opposite should have occurred”, as reported by The Economist.
The aftermaths of the financial crisis have caused America’s recovery to be slower than that of other economies, especially emerging ones. A weaker dollar is expected, given the relative cyclical weakness of America’s economy. That suggests America’s monetary policy will stay looser for longer, pushing the dollar further. A weaker dollar would also aid in assisting the global economic rebalancing by helping to renew America’s economy towards exports. Hence, it should help rather than hinder the global recovery.
However, dangers of the falling dollars still remain. Firstly, the dollar’s decline is distorted. China, has kept its currency tied firmly to the greenback. This baffled the adjustment of China’s economy by fuelling risky domestic asset bubbles and placing unnecessary burdens on other, more flexible currencies. Next, the America’s monetary policies are unsustainable. The debt burden is set to double and rose in no time. Lastly, the financial crisis has accelerated the relative shift of economic heft out of America and eventually hastens erosion of the dollar’s dominance.
The America’s monetary mess will stay for years, but inflation will not soar suddenly. The greenback will not lose its reserve-currency status immediately as the euro or the yuan are not ready to seize it.
Will the falling dollar complicate life for countries with floating exchange rates?
Having a weaker dollar is good news for the world. Amid the current global economy recovery, there is a returning appetite for high risk investments, such as corporate bonds and equities. Most investors chose to bank in on the safest and most liquid assets, American Treasuries. The demand for safe assets caused a rally in the dollar in the past months after the collapse of Lehman Brothers September 2008.
Since the stockmarkets and economies have recovered, the dollar’s weakness has surfaced. It is affecting countries such as Brazil, Canada and Europe with floating exchange rates and has prompted a few responses: direct measures to stop currencies rising; attempts to talk them down; or acceptance of a weak dollar.
In the past week, the dollar slide to about $1.50 to the euro, just as Henri Guaino, an adviser to Nicolas Sarkozy, the French president, described such a rate as a “disaster” for Europe’s economy. Europe’s efforts to contain the dollar’s weakness have had less impact.
The other euro-zone countries are less rattled. “A strong euro reflects the strength of the European economy,” said Walter Bos, the Dutch finance minister. Europe’s export powerhouse, Germany, felt that the nation can live with a euro worth $1.50 because demand from the Middle East and Asia for its specialist goods are insensitive to price. However, France is struggling. A report by the European Commission showed that French exporters lost market share in the euro’s first decade. Other euro-area countries such as Greece, Ireland, Italy and Spain have benefited slightly from the recent economic revival through lower debt’s premiums.
America needs a weak dollar to help revive its economy and reorient it towards exports and away from consumer spending. Since China and some other Asian countries track the dollar, the burden of exchange-rate adjustment falls on the euro. It is reported that Mr Trichet, Joaquín Almunia, the European Union’s economics commissioner, and Jean-Claude Juncker, who chairs the Eurogroup of finance ministers, will visit China later this year to press for a stronger yuan.
Experts advised that as long as America keeps its interest rates low, attempts by others to tighten policy are likely to mean a stronger currency.
“What looked like co-ordination was really coincidence,” says David Woo of Barclays Capital. Recovery is more uneven. Countries with greater exposure to buoyant emerging Asia are optimistic about a weak greenback. For most countries, it is threatening to have a rocky dollar.
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