Caution: Falling Dollars

Sebastian Mallaby has a piece on what a declining dollar means for the world economy. Although he relies on the now-debunked story of supermodel Giselle Bundchen refusing to be paid in dollars, there is real reason to worry about the fate of the dollar.

Normally a falling dollar would mean rising inflation, but we’re not seeing any real signs of that—at least not in the US. That suggests that something else is going on with the dollar. Mallaby suggests that the world is tired of buying American debt. That may be true at the moment, but even with the sub-prime mortgage problem, investing in America still makes sense. In fact, it makes sense now more than ever since the dollar is so cheap relative to the Euro. If the sub-prime mortgage situation is resolved (which will happen sooner or later), then an undervalued dollar would lead to a massive influx of foreign investment in the US. Not only that, but it helps Americans by making the cost of American goods that much cheaper on world markets.

The big problem is that the markets don’t know how bad the sub-prime mortgage problem is: and until they do, the speculation will keep pushing the dollar lower. One of three things could happen: the problem could be much worse than expected in which case the dollar could drop precipitously; the problem could be about as bad as some would predict in which case the dollar will stay where it us until the situation is resolved; or the sub-prime problem could be not nearly as bad as expected, in which case the dollar will have been undervalued and may very likely overcorrect before settling back down.

Unfortunately, we have no idea which path is going to end up being the direction of the dollar, and there’s nothing world markets dislike more than uncertainty. Until the uncertainty ends, the dollar will keep being pushed down.

There is a silver lining—the fundamentals of the US economy are strong. GDP growth is solid. Wage growth is good. Productivity is on track. The weakness is due to high oil prices (which are being pushed up by speculation and won’t stay this high forever) and the ensuing drop in consumer confidence. However, those trends aren’t necessarily fatal.

Now is a crappy time to be planning a European vacation, but that doesn’t mean that the US economy is going down the tubes. The dollar’s drop is due to uncertainty rather than any severe structural problems with the US economy, and that means that at some point the markets will make a correction. There’s some reason to worry about a declining dollar, but there’s no reason to panic either.

One thought on “Caution: Falling Dollars

  1. What with the oil prices on the rise, I am, for once, happy about the weak dollar – for explicitly selfish reasons:
    The price for a litre (about 1/4 of a gallon) of diesel has gone up from 1.02 Euros (as of January 3rd, 2007) to 1.34 Euros (as of November 13th, 2007). At a normal gas stop (about 44 litres, ten gallons, roughly), that makes for more than 13 Euros more each time I pump gas in November compared to January. (Currently two times a week… that means, at the end of the month, I will have nearly 100 Euros less at my disposal, just due to increasing gas prices. Being at the lower end of the income table, to begin with, you can imagine I am rather upset about that.)
    I can only about imagine how bad things would be if the Dollar was stronger compared to the Euro. As oil is paid for in Dollars, the strong Euro is actually helping keep prices from soaring even higher than they are doing now.
    So from this very narrow-minded point of view, I am actually hoping that the Dollar does not come back up too soon.


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