The fall of US dollar
The US dollar has continued its recent decline, hitting fresh lows against the pound.
Sterling hit a 14-year record against the dollar on Tuesday – above $1.99 on currency exchanges – almost breaking the key $2 rate.
The downward pressure on the greenback looks set to continue, with wide-ranging consequences at home and abroad, for both companies and consumers.
How will the dollar’s slide affect ordinary people?
Back in the 1960s when governments, not markets, decided the fate of currencies, Britain once lowered the pound’s exchange rate by 18% while telling the public that "the pound in your pocket" had not been devalued.
Of course it had. The purchasing power of the pound was eroded as the cost of imported goods went up, although British firms were able to sell their goods abroad at more competitive prices.
The US is now going through the same process. As the dollar falls against other currencies, goods imported from abroad become more expensive for US consumers.
The impact will be particularly be felt on oil prices, as two-thirds of US oil is imported.
Dearer oil means petrol price hikes, higher transport costs for goods and more expensive heating.
I don’t live in the US, but I’m planning a trip there to do some shopping. Surely it’s good news for me?
Yes, indeed. Your pounds, euros or yen will buy more dollars than before, making goods in US stores much cheaper for you.
But the upward pressure on prices could lead to a hike in US inflation this year, which would cancel out some of those gains for those of you planning to travel later.
And if you work in tourism, you have to bear in mind that people in the US are less likely to visit your own country because their holidays abroad will become more expensive.
What about the wider US economic impact?
The fall in the dollar could actually do the US economy some good, by helping to reduce the country’s huge trade deficit – the difference between the amount the US imports from the rest of the world and the amount it can sell to the rest of the world.
That deficit is now heading above $800bn for 2006, or 7% of the US economy.
As the dollar declines in value, US consumers have an incentive to buy domestic goods rather than foreign ones, helping to correct what has become a huge global imbalance.
But if US inflation does surge ahead, it might force the Federal Reserve, the country’s central bank, to raise interest rates in a bid to keep price rises in check.
That could make the country’s highly-indebted consumers more reluctant to buy any goods at all, choking off economic growth and increasing fears of an economic slowdown.
How will UK jobs and industry be affected?
The dollar’s fall could be bad news for UK and European manufacturing industry.
It will create difficulties for UK and other firms trying to sell their goods to the US public, since Americans will have to pay more for them in dollar terms.
In recent years the US has been the engine of world economic growth, and its export market has been very important.
But some Europeans now argue that with an economic revival at home, the impact could be lessened.
How long will the dollar’s slide continue?
While no one can predict the course of currency markets, the pressures are growing on the dollar.
Economists have been saying for many years that the growing trade deficit is unsustainable in the long-term.
In addition, the US economy is weakening, while the economies of Europe and Japan are getting stronger.
This is likely to mean interest rates rising in those countries, which could attract more funds from the US.
The damage of the dollar glut
Money printing to prop up the U.S. economy has spawned more of the same around the world, fueling a global boom and an inflation spiral.
We’re in the midst of a leveraged-buyout mania and a worldwide stock frenzy, running the gamut from just plain wild to completely out of control.
From time to time I find myself wondering: How did we get here? So today, I’m sharing my thoughts on that subject because if you don’t know how you got to where you are, it’s hard to be prepared for what may happen next.
In the beginning . . .
To make a long story short: The process was started by money printing in America to bail out the last bubble.
That induced money printing in much of the world because so many countries had linked their currencies to the dollar. More importantly, the very regions that were primed to grow — think Asia, India and the Middle East — exploded, in no small part, thanks to money printing. Thus, America’s housing boom kept our economy growing. Growth in the other parts of the world I just mentioned, together with the attendant commodities boom, conspired to create the worldwide growth (and inflation) that we have experienced.
A lot of what’s transpired has been a function of absurdly low interest rates, given the level of inflation around the world, and the collapse in risk premiums, aided by ratings-agency alchemy, which has allowed debt — from moderately risky to total garbage — to be spun into high-quality credit structures. In other words, the debt markets have acted as unindicted co-conspirators in the frenzy.
Stuffed to the gills with dollar bills
A major reason why our Treasurys market has traded as well as it has stems from the accumulation of dollars by the aforementioned regions and their desire to keep their currencies weak against the dollar. (China, Japan, South Korea, Taiwan and India have accumulated more than $2.5 trillion in less than 10 years, according to the May 23 Financial Times.)
The trillions of dollars printed "forced" those countries to print trillions of dollars’ worth of their own currencies to keep them from appreciating too quickly. After they printed their currencies to buy ours, they wound up buying mostly Treasurys with those electronic greenbacks (that is, until recently).
Thus, currency-suppression techniques and blind reliance on formulas on the part of ratings agencies, combined with organic growth, plus the madness of the crowds, have brought us to where we are. But important changes are under way that at some point will derail the process I’ve just described.
First of all, Kuwait’s dollar de-linking and China’s sliding of the band (to pick the two most recent examples) will, at the margin, require less dollar buying and ultimately less Treasurys buying. Additionally, it appeared the Chinese were already spending fewer of their dollars on Treasurys and more on commodities, even before they took a flier on the Blackstone purchase. This is a roundabout way of saying that the world’s bond markets might finally experience rising rates as the ranks of buyers thin out.
LBOs: Gorge now, regurgitate later
One of the unwritten beliefs of folks in the leveraged-buyout (LBO) crowd is that they’ll be able to finance any wild idea they can come up with. So far, that has been the case. But we are going to hit a point where the cumulative effect of all this exchanging equity for debt will swamp the debt market, and the LBO party will be over. It’s not possible to predict when speculative forces finally will choke the debt buyers, though that moment should be recognizable as it occurs.
Lastly, I believe that the world economy’s growth will at the least be tested, if not completely undermined, because U.S. economic growth is in the process of slowing down. I think it will continue to slow as consumers are tapped.
The main engine that kept them going after the last stock bubble was the real-estate ATM, which is now broken. Further, the recent tightening of credit standards and increasing interest rates in the bond market — not to mention the high price of gasoline — will compound the problem.
A sanguine state of rationalization
In the meantime, it’s been onward and upward for stocks, thanks to the blind faith in LBOs and a never-ending global boom, and a market that "acts well" (reinforcing the belief that market action never lies about what the future holds), factors that lull folks into a sanguine state of rationalization. Ultimately, I believe that market action will fool people. The one thing that I am most certain of is that there is going to be a dislocation — because never have so many rationalized so much with so much leverage.
The Fall of US Dollar