As Dollar Droops, Some Win, Some Lose

Monday, November 19th 2007, 6:43 am
By: News On 6

WASHINGTON (AP) -- The once-mighty dollar has been drooping lately, falling to historic lows against the 13-nation euro, the Canadian "Loonie" and other foreign currencies. Here are some questions and answers about the dollar's slide and the impact it will have.

Q: Why is the dollar so weak all of a sudden?
A: The dollar has actually been falling in value since early 2002. It dropped nearly 25 percent over that time against a group of major currencies, according to an index maintained by the Federal Reserve. The problem is that the slide has accelerated sharply since late summer.

Q: What happened?
A: The credit crisis that hit with ferocity in August spooked foreign investors, causing them to pull some of their investments out of U.S. markets and put them in other countries. That meant the foreign demand for dollars fell, and the currency slid in value.

Q: Was that all that occurred?
A: No. The Federal Reserve contributed to the slide when it decided Sept. 18 to cut a key interest rate it controls by a bigger-than-expected half point. The Federal Reserve wanted to lower U.S. interest rates to boost the economy and prevent a recession. But the action also prompted some investors to move their holdings to other countries where interest rates were higher. Again, the forces of supply and demand meant that if fewer people wanted dollars, the price of the currency would fall.

Q: Is this such a bad thing, given that the dollar has been weakening for more than five years?
A: It depends on who you talk to. American tourists traveling to Toronto, London and Paris are experiencing the pain of having to shell out more for hotel rooms and restaurant meals. The dollar is
down 16 percent against the Canadian currency since the start of this year. It is down 10 percent against the 13-nation euro and 4 percent against the British pound during the same period. Those declines also mean U.S. consumers face higher prices for imported goods. The price of imported oil has soared in recent weeks, trading briefly above $98 per barrel. Oil is sold in dollars and producers are demanding higher prices to compensate for the dollar's decline.

Q: Does anybody win from the weaker dollar?
A: American manufacturers and farmers are enjoying a surge in export sales to record levels as the weaker dollar makes their goods cheaper and thus more competitive abroad. The export boom is helping to lower the U.S. trade deficit this year following five straight years of record highs. The growth in exports is helping cushion the economic impact from the steep slump in housing, adding nearly a full percentage point to growth in the most recent quarter. Without the export boom, many economists believe the country would be in much greater danger of falling into a recession from the combined blows of the housing slump, the credit crunch and soaring energy bills.

Q: So why not let the dollar keep falling?
A: As long as the decline is orderly, economists think the weaker dollar is exactly what is needed to lower the trade deficit to more manageable levels. The concern is what might happen if the decline is too rapid. That could trigger a rush for the exits by foreigners, sending U.S. stock prices plunging in value and interest rates soaring as demand for U.S. bonds suddenly falters. All that could send the country into a recession.

Q: How big a threat is that scenario?

A: Probably small. The U.S. economy is still the world's largest and its financial markets remain attractive places for foreign investment even with the dollar's slide.

Q: How has the Bush administration responded to the dollar's decline?
A: Benign neglect might be the best way to describe the administration's approach. Treasury Secretary Henry Paulson continues to answer questions on the dollar by saying "a strong dollar is in our nation's interest." But the administration hasn't done anything to back that up, such as intervening with other countries to buy dollars to support the greenback's value. Private economists, however, generally support Paulson's tacit acceptance of the dollar's decline. A weaker dollar boosts exports and lowers the trade deficit. That helps the administration politically by easing congressional pressure to erect protectionist
trade barriers.

Q: So where does the dollar go from here?
A: Federal Reserve Chairman Ben Bernanke told Congress recently that he believed economic conditions would lead "to a sound dollar in the medium term." And even more significantly, Bernanke told lawmakers that the Fed believed current economic risks were roughly balanced between weak growth and higher inflation. That was viewed as a signal that the Fed may not cut interest rates further. No further Fed rate cuts would mean foreigners would get higher returns on their U.S. investments, taking downward pressure off the dollar.

Many economists believe the dollar will start to stabilize as the U.S. trade deficit falls further. Fewer dollars pouring into foreigners' hands to pay for imports will ease pressure on the greenback. Some analysts believe the dollar may even start to rise in value against European currencies although they expect it will continue to fall against the Chinese yuan. China is still running record trade surpluses with the United States. American manufacturers contend China is manipulating the yuan's value, keeping it as much as 40 percent lower against the dollar than it should be. The Bush administration, which will hold
another round of high-level economic talks with China in December is pushing China to move more quickly to let the yuan appreciate in value to lower America's deficit.

Q: Will currency markets, where $3 trillion in currencies change hands daily, become less turbulent?
A: Probably not right away, analysts say. "I think we will have significant volatility over the next three to six months before the situation stabilizes. The U.S. economy will be close to a recession and the financial system will remain tenuous," predicts Mark Zandi, chief economist at Moody's