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.