Global Investing - The Weak Dollar

A weak U.S. dollar is the result of devaluation of American currency with regards to its purchasing power when held against foreign currencies. Supply and demand determine the currency value within the global market and it is the positive or negative shifts in supply and demand that unveil the strength of the U.S. dollar when compared to foreign currencies.
The weak dollar is important because it affects not only the American economy but the international economies as well. The economy of the United States is the largest in the world and the most open, which is why most foreign countries flock to invest in it.

Today, value of currency in the United States is considered weak. This means that in relation to our global economic counterparts, the value of the U.S. dollar has fallen and is worth less and offers less purchasing power than the other major currencies. The weak dollar acts as a dual-edged mechanism presenting both monetary advantages and disadvantages. The advantage of a weak U.S. dollar is that it contributes greatly to the domestic economy. It is "…easier to sell goods in foreign markets…" ("Strong Dollar, Weak Dollar," n.d.), is less competitive, American tourism increases and foreign investments peak.

The disadvantages are that foreign imported goods become expensive, American cost of living is propelled, international travel for Americans becomes expensive and foreign investment in the American market stagnates.
A weak dollar in the U.S. has not always been the norm. From 1995 to 2002 the value of the U.S. dollar rose significantly while foreign currency value rapidly declined. The Japanese economy experienced stagnation, the unemployment rate in Europe jumped to an all time high and financial instability grew in countries like Russia and Argentina. Then the booming economy of the U.S. offset the international turmoil experienced by Asian and European countries by attracting a rush of foreign countries to partake in America's growth and stability. These countries began investing foreign currency in the American market as a way of protecting the value of currency in their own country.

In 2002 and 2003 we began to see a decline in the U.S. dollar value. During this time the Canadian dollar increased by 20 percent in comparison to the U.S. dollar and an additional 7.5 percent in 2004. As of January 2005 the "dollar had lost around 32 percent against the Euro and 22 percent against the Yen" (McMahon, 2005) and currently the Chinese Yuan, pegged at 8.28 Yuan to the U.S. dollar, is causing a stir within the global economy because its flat rate to the weak dollar is adding to China's increase in exports "…at the expense of its trading partners" ("Chinese Yuan peg 'difficult'," 2005).
In 2004, "foreign investors sought out alternatives to U.S. assets" ("Russia, China attract capital," 2005.) During this time private capital had increased by $53 billion with the bulk of 60 percent of the funds going to China and 25 percent going to Russia, leaving a very small amount for other counties. Does this mean the devaluation of the U.S. dollar promotes investment or poses a threat? It does as both.

Economists diligently work to improve the value of the U.S. dollar to sustain a desirable American economy and currency. On February 4, 2005, Federal Reserve Chairman Alan Greenspan addressed a conference in London announcing the expectation of a reduction of the current U.S. account deficit. In spite of the spiraling decline of the U.S. dollar, the United States market had not demonstrated an appreciable weakening. America's sustained growth in consumption had been a major driver in global growth in foreign trade and if the United States should decrease consumption, it could perpetuate a global economic slow down.

The Federal Reserve Board, a centralized financial system of the United States, functions to promote continued economic growth. It creates and utilizes economic policy to stabilize the United States financial market and has greatly contributed to the U.S. dollar historically being the monetary unit most utilized in the currency trading market.

Foreign exporters have, for the most part, been willing to accept reduced profits to maintain their United States market share. This has been mostly true in the European sector. The concern, however, is that if the weakening dollar trend continues, exporters to the United States may no longer choose to continue to tolerate these decreased profit margins. Additionally, Greenspan addressed a need for restraint on government spending. There is a resounding voice reiterating the need to reduce government spending in order to diminish the need to borrow monies from abroad.

Also proposed is the need to increase household savings to lessen the need to borrow from foreign investors. The increase in home mortgage debt has been a significant influence in the decrease of personal savings. The interest rate in 1993 for personal savings accounts hovered in the vicinity of six percent. That number now lingers at about one percent. The fall in interest rates has perpetuated the launch in the cost of homes and has subsequently increased the mortgage debt of the American household.

The United States has experienced continued deficits since the early 1980s and has hence converted its reputation as the world's largest creditor to the largest debtor nation. Some foreign banks have already begun to shift their reserve holdings from the U.S. dollars to Euros due to the insecurity in the condition of America's external deficit. Many financial experts fear that the vast holdings of U.S. dollars in foreign markets could put America in a vulnerable financial position if those countries should choose to unload their holdings in response to displeasure with United States foreign policy or action.
The U.S. dollar has been regarded as the most dominant world currency for years but with its continued devaluation, its potential as a threat has increased and cause for concern has spread internationally. The American currency is becoming less desirable due to its continued downward trend; the more it weakens, the more speculation arises as to how long it can continue to be the favored currency to trade.

The current account deficit (a broad measure of United States global trade and investment) and the federal budget deficit account for the two major factors influencing the decline of the dollar. Since President Bush took office in 2001, the United States has been relying less on capital consumption and more on foreign investment, which in turn caused increases in the account deficit over the years. Experts do not foresee a significant decrease in the debt any time soon and predict a continued decline of the U.S dollar in the future. This expectation has increased the sales for U.S. companies overseas while driving up the costs of imports in America.

More and more people are discovering the value of the dollar is not as high as it once was and international companies are beginning to experience the negative effects of the weak dollar. For example, Mercedes- Benz announced earlier this year that they are delaying the launch of their compact B-Class for at least a year because of currency concerns. The U.S. dollar's devaluation has increased cost of European exports in the American market. The European Union is defiantly feeling a pinch from the dollar's decrease. Similarly, "the weakening of the U.S. dollar against the euro automatically increases the amount of export subsidy which has to fill the gap between the EU indicative prices for cereals, dairy products, beef and sugar and a dollar-denominated world price" ("Weak dollar adds to CAP," 2004).

Asian economies are also feeling affects of the decreasing U.S. dollar. Countries in Asia are the largest holders of U.S. debt. Japan has U.S. treasury holdings of $720 billion and China is currently holding $174 billion. Profits seen from selling their goods in the U.S. have been invested into treasury bonds. As the value of the dollar has continued to decline, so has the value of their investments. In an attempt not to influence a worldwide recession, analysts believe that countries in Asia have little choice but to maintain their current holdings in the U.S. treasury bonds they have. It is feared that if these countries were to cash out of their investments and take their losses, they would in turn cripple their own economies.

Today, many people have expressed great interest on how the weak U.S. dollar affects the domestic economy. Many within the United States feel a strong or weak dollar is irrelevant to daily living because the dollar is worth its face value when purchasing products. However, the strength or weakness of the dollar ripples throughout the country from the American household to the small business owner to huge corporations. Over the past two years the dollar has weakened against foreign currency to a rate that has not been seen for nearly 10 years and the effects are being felt by everyone.

A falling dollar will affect the price of foreign products. When the U.S. dollar looses value relative to foreign currencies, foreign products become more expensive for the U.S. buyer. As seen in 2002, the dollar had fallen by 32 percent against the Euro. This devaluation of the U.S. dollar caused the prices of European goods to increase nearly three times over the past several years (Francis, n.d.). Because foreign goods become more expensive within the U.S. market, many Americans will turn to the more affordable American-made goods and services.

For example, households in the United States are feeling the pressure from the rise of the Euro as a stronger currency. The cost of European Brie has increased from $6.99 to $8.29 in one year at import-food shops in Chapel Hill, North Carolina, turning a normal trip to the grocery store into a wallet draining experience.

The decline in value of the U.S. dollar has subsequently hurt the foreign job market and economies of many European and Asian countries. Many foreign leaders have pressed President Bush to decrease the U.S. trade deficit; this would promote a stronger dollar and help to stimulate their economies. Although, the weak U.S. dollar has helped to pull the U.S. economy out of recession and increase the of production of goods and services, boosting the demand for jobs, the call for a strong dollar continues to be echoed.

Currency fluctuations can also affect foreign investment in American companies and products. When the U.S. dollar is strong against foreign currencies it encourages U.S. companies to pursue overseas investments yielding higher returns or to expand businesses to foreign countries due to lower costs. In contrast, when the U.S. dollar is weak foreign companies are attracted to the U.S. market. They are motivated to move production facilities to the U.S. because the operating cost are more desirable. The Los Angeles entertainment industry, for example, has seen a remarkable increase in foreign business wanting to film within the U.S. because of more affordable on-the-ground costs, stuntmen and production costs.

Similarly, Toyota has built seven manufacturing facilities within the United States hiring more than 100,000 people. In this case, the weak dollar has helped the American economy by providing jobs and having a positive effect on the American unemployment rate.

The down side of a weak U.S. dollar is that imports of critical goods increase. Steel is a much needed commodity for US auto makers. When the U.S. dollar weakens steel costs increase and this cost increase is then passed to the consumer through an increase in automobile prices.

Ultimately, the weak dollar indicates a need for attention for both present day problems and for future concerns of the economy as a whole. But, we must ask, is having a weak U.S. dollar really a bad thing? It depends; the weak dollar can be viewed as either an investment or threat because its affect is based on perception and future goals. Foreign investors fair well from the weak dollar as an investment; the purchasing power of their currency increases, creating the ability to buy and invest more and operate their companies within the United States at reduced costs.

U.S. firms appear to have competitively low prices compared to foreign companies, U.S. sales of goods and services increase, and U.S. tourisms booms. On the contrary, a weak dollar can also pose as a threat. Foreign countries will experience a decrease in exports into the U.S. due to increased prices that are unaffordable to Americans and foreign investments in the U.S. may yield fewer earnings than expected because the dollar continues to weaken. U.S. firms also feel the threat. Consumers incur higher cost on their favorite imported goods, vacationing abroad depletes American bank accounts and businesses find it more expensive to operate and compete in the foreign market.

"The big mysteries, then, are just how much further the dollar might fall and what that means for the world's largest economy"(Gongloff, 2003). U.S. policy makers would like the weak dollar to promote the economy and fight deflation but only time will tell.

As of now, analysts believe that "currency markets go in trends…" (Gongloff, 2003) and currently the dollar is experiencing a downward trend. It's highly "unlikely that there would be a dramatic plunge in the dollar's value. Europe won't sit and watch its currency appreciate forever… and Japan… promised… to keep the Yen from getting too muscular" (Gangloff, 2003).
For now, as the weak U.S. dollar continues to be the favored policy for improving the economy, the outlook for the dollar in 2005 is that it will most likely continue to decline, with a few periods of relative stability.