The Falling Dollar

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The U.S. dollar has fallen to its low for the year. Anticipating a recovery, many investors are moving from relatively safe dollar-based securities back to stocks. With the Fed keeping interest rates artificially low and the possibility of further declines in the dollar, investing in the U.S. currency is not very attractive. How will this affect our economy? It can get complicated, but a couple of key points are worth highlighting.

First, a weaker dollar means it takes more of our (U.S.) currency to purchase a given quantity of imported goods. Specifically, oil prices will rise, which will increase the price of much of what we buy.

Second, our burgeoning national debt must be financed with a weaker dollar. Although the Chinese have played a big role in the past and currently hold about $1.3 trillion in U.S. dollars, they are becoming less interested in financing more of it. With Fed-induced low returns, they might be better off holding Euros, British pounds, or a market basket of currencies instead. One possible short term solution is that the world will view the dollar as the preferred currency and will continue to hold them even with a low rate of return. Recent skepticism from world leaders suggests that this will not be sufficient. What is more likely is that either Washington will have to print more dollars or the rate of return on dollars will rise. Both of these alternatives are inflationary.

By the way, some Keynesians claim that a weak dollar is good for imports because U.S. products will cost less abroad. The problem with this idea is that increasing production costs caused by the weak dollar (higher oil prices) can easily counter this effect, so don’t count on this over the long term.

The bottom line is that Obama’s massive spending has sown far too many seeds of inflation, and an economic upturn is the water that will make them grow. Unfortunately, this means any recovery we get in 2010 will probably be modest.

4 Comments

4 Comments

  1. George77  •  Sep 9, 2009 @12:11 PM

    As the Rev. Wright would say, Obama’s deficit chickens are coming home to roost. Only problem is we have to pay for them.

  2. Jeffo  •  Sep 9, 2009 @1:42 PM

    Dr. Parnell, Thinking this through on inflation, will not wages also inflate? In other words, people feel psychologically better so to speak, because they see the pay check is bigger. However, at the same time the have the same or less purchasing power, but this is a more subtle aspect. This subtle trade-off effect to me seems to buy more time for the administration to continue the loose fiscal policy in order to fund expansion of government programs. Is this part of the strategy they employ?

  3. John Parnell  •  Sep 9, 2009 @1:59 PM

    There are always winners and losers in any economic shift. The net effect of a weak dollar, however, is not positive. Keep in mind that inflation-based wage increases don’t happen until after the inflation occurs. Purchasing power declines for a year or so until the market begins to factor the inflation into the wage rate. This is a real problem when inflation and unemployment are both high, as they were in the Carter years. If unemployment stays high, wage rates will remain “sticky” in many industries even with inflation because it is not necessary to grant large wage increases to retain workers. Purchasing power will decline across the board. It’s the market’s way of compensating for fiscal irresponsibility.

    I can only speculate about your assessment of Obama’s broad strategy, but I think you’re on the right track. Fundamentally, the Obama administration believes that the right “experts” (left-leaning economists and politicians) can constantly manipulate the economy and achieve some degree of prosperity. They don’t understand that their moves (the stimulus package, cash for clunkers, etc.) set in motion a chain reaction of market responses that create more harm than good in the long term. Of course, this creates the need for even more government manipulation. You can see where the spiral is headed if we don’t put a stop to it.

  4. Jeffo  •  Sep 17, 2009 @7:50 AM

    Dr Parnell I came across a good little book called “Whatever Happened to Penny Candy” by Marbury. I highly recommend it. It is short and very easy to read. Explains alot about what you are saying above and more. It is alarming to see how the government has manipulated the money supply for political purposes – but the damage this does is the untold story. The Fed is heroic as portrayed in the media, but in large part they simply aid and abet corruption and mismanagement by Congress and Presidents.