The Droopy Dollar: The Pros and Cons of our Declining Dough

On November 24, 2004, the value of the U.S. dollar fell for the seventh time in a month, hitting a record low of $1.31 to one euro.

Economists say that the dollar will probably continue falling, despite President Bush’s "Strong Dollar Policy." What is this policy? And what does a weaker dollar mean to the U.S. economy and to our everyday lives?

A matter of language

President Bush’s Strong Dollar Policy allows the global market to set the value of the dollar. Despite the "Strong Dollar" title, this approach allows the dollar to weaken upon market forces’ demand.

Although "The Market Value Policy" would be a more accurate title, the Bush administration uses "Strong Dollar" because of the term’s positive psychological effect. People generally think that a strong dollar is good for the economy and a weak dollar is bad. But when it comes to the dollar, the words "strong" and "weak" don’t necessarily maintain their everyday meanings and connotations. Within the context of the global economy, "weak" can be desirable and "strong" can be a threat.

Why a weak dollar can be a good thing

When the value of the dollar drops, it becomes cheaper for foreign consumers to buy American goods, so U.S. production increases to meet the increased demand. This is good news for American companies that sell goods and services overseas.

Conversely, when the dollar is strong, it is more expensive for foreigners to buy American exports. This causes a drop in U.S. production and exports.

The simple logic of this equation can be disrupted, however, when political opinions come into play. For example, European consumers have threatened to boycott American goods to protest the Iraq war. If this happens, the weak dollar may not cause increased foreign spending on American goods.

Why a weak dollar can be a bad thing

In addition to making Aunt Erma’s trip to Paris more expensive, a weak dollar keeps foreign investors from buying U.S. securities.

Other countries’ central banks, such as the Central Bank of China, buy U.S. Treasury securities when the dollar is strong, a practice that finances our national debt. In essence, other countries are our creditors.

The U.S. must borrow from other countries because we are spending more than we have (which equals a debt of $7.5 trillion) and consuming more than we produce. Some economists say that the devaluation of the dollar will require the U.S. to be more responsible, meaning spend less and produce more.

The thing about interest rates

The devaluation of the dollar poses another problem: higher interest rates for Americans. As the dollar weakens, U.S. Treasury securities become a high-risk investment, so foreign investors demand higher returns. This translates into higher interest rates on the money that American companies and individuals borrow.

In day-to-day terms, this means that mortgages and car loans will become more expensive, so housing markets and auto sales are likely to decline.

A cause of inflation

Although inflation is the result of many factors, a weakening dollar can be one of them.

A less powerful dollar causes the price of imported goods to rise, but that doesn’t mean that Americans will buy American, since U.S. producers follow suit and raise their prices as well.

This trend has already begun - consumer prices are rising on the whole, with U.S. companies charging more to match the higher costs of imported goods.

In response to higher prices, Americans could buy less, which would result in an economic slowdown unless exports continue to rise. But Americans may just keep on spending in the face of higher prices, which can be good for the American economy but bad for the personal pocket book.

What do you think?

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Article Posted on: 12/7/2004