Depending on who you read, the dollar’s steady weakening this year has either been exactly the tonic the manufacturing sector needs to boost exports and discourage imports or it is the beginning of the end for the dollar slipping into terminal decline. In reality it can be a bit of both and here’s why. The steady deterioration in the value of the dollar has been beneficial to exporters and to the balance of payments with a narrowing of the trade deficit as imports have fallen faster than exports. In the short term, with domestic consumption depressed exports are the only opportunity for US manufacturers to increase sales. So a short to medium term boost to exports is a good thing for the US in the current situation. Apart from helping exporters it acts like a kind of silent protectionism, discouraging imports from stronger currency areas like Europe and Japan while boosting exports.
Putting the dollar moves into context we have heard a lot of talk recently about a dollar collapse but if we look at the movement of the dollar against the world’s next largest currency the Euro it has moved from a low of $1.60/Euro in the first half of 2008 to a high of $1.25 at the turn of the year at the height of the “flight to safety. Since then, the dollar has come off again but it is still only midway at $1.49 today. In fact it’s not far off the average for the whole of 2007. The move is more dramatic against the commodity currencies like the Australian dollar which has benefited from a strong economy and rising commodity prices but the only valid measure is against the big currencies like the Euro and Yen. A weakening dollar is actually more of a problem for the Asian currencies who cannot afford to let theirs rise too much against it or exports suffer. Even China, with effectively a peg, is paying a price in depressed living standards and inflated import costs trying to stay with the dollar.
So the dollar has not collapsed but the trend has been downward for much of this year and the fear is the trend could continue. Seeing the direction the currency has been going with the back drop of zero interest rates, massive and growing national debt and quantitative easing is making domestic investors and overseas holders of US assets nervous. The Fed will at some stage face a dilemma on interest rates, as the FT remarked in a report looking up to the end of the next decade borrowing is going to go through the roof. The report asks as recovery takes hold and competition for investment funds increases will the Treasury continue to be able to raise trillions of dollars of debt at below 4% as it can today? Interest rates will rise and the debt level will become unsustainable. This is prompting a massive debate about how the current account should be if not balanced then reigned in to sustainable levels, about the time frame and whether it should be done via tax increases or spending cuts. For now it looks like the administration is set on tax increases and increased borrowing. But one thing that all agree, the US cannot run massive levels of national debt indefinitely or there really will be a collapse of the dollar. In the meantime, importers should start to think about how viable their model will be if currency costs add another 10-15% to prices over the next twelve months.