speaking about currency values-
World economy
The not-so-mighty dollar
Dec 4th 2003
From The Economist print edition
The dollar's slide has further to go, but if handled carefully it could help not harm the world economy
“DOLLAR Plunges” or “Euro Soars” make good front-page headlines. But the dollar's slide over the past two years has seemed too gradual to qualify for such treatment, and has mostly been reported on inside pages, along with more run-of-the-mill economic news. Yet the total movement in the dollar-euro exchange rate has been far from tame: in July 2001 one euro bought just under 84 cents; this week it hit a new high of over $1.20. Depending on how you look at it, this is a 44% rise in the euro or a 31% fall in the dollar. However measured, the change in the relative values of the two currencies is significant for a host of reasons, and deserves a lot more attention, not least because the dollar seems likely to fall still further (see article).
To most people exchange rates simply determine how much cash they have to spend when on holiday abroad. But the dollar's exchange rate against the euro is surely the world's single most important price, with potentially much bigger economic consequences than the prices of oil and computer chips, for example. The strength of the dollar affects trade balances, capital flows, growth rates, profits, share prices, inflation rates, interest rates and even the relative size of economies. The euro area's GDP was only 60% the size of America's in 2001. If current exchange rates are sustained, it swells to around 80%. If the economies of Britain, Sweden and Denmark are added to the euro area, the European Union now has a slightly larger economy than that of the United States.
At first sight it seems odd that the dollar is falling. The American economy and profits are sprinting ahead, while the euro area's economies are barely able to maintain a walking pace and Japan is just getting off its knees. In the year to the third quarter, America's GDP grew by 3.5% and euro area's by a dismal 0.3%. Although Japan's real GDP grew by 2.3%, its nominal GDP was flat.
America's red ink
Surely, stronger American growth should be pushing the dollar higher, not lower? That is what happened during the late 1990s. But the problem this time is that, if domestic demand grows much more strongly in America than in its main trading partners, America's already large current-account deficit swells further because it imports more. America then needs to borrow even more from the rest of the world to finance that deficit. And the real cause of America's growing taste for imports, of course, is not unfairly cheap production in China—usually named as the culprit—but its low saving, the result of rampant household borrowing and a huge federal budget deficit. So long as these persist, it will take an even bigger fall in the dollar to correct America's external deficit.
A few years ago, foreign investors were eager to purchase dollar assets. But now investors seem to be losing their appetite. Foreigners were net sellers of American shares in the third quarter, leaving America dependent on other governments' purchases of American Treasury bonds. Net capital inflows into America fell to only $4 billion in September, their lowest for five years. If the demand for dollars falls short of supply, then either the dollar must fall or American bond yields must rise to make dollars more attractive to investors.
Is a weaker dollar cause for concern? For America, it should be a boon, helping to boost exports, profits and jobs. The usual worry that a falling currency will lift inflation is also lessened, because America still has ample spare capacity and its inflation rate (1.3% on its core measure, excluding energy and food) is, if anything, too low—the Fed would welcome a modest rise. If a continuing gradual fall in the dollar trims the current-account deficit, this could, paradoxically, also lessen the chance of a sudden collapse of confidence in the dollar.
Europe's opportunity
In Europe a weak dollar is feared and resented. Politicians and businessmen worry that America's gain will be their loss, and that their own firms will become less competitive as a result. And yet a rising euro need not be bad news for Europe. In fact, if the European Central Bank (ECB) responds in the correct way, it could be just the opposite: the kind of good news the euro area badly needs.
Unfortunately, that is a big “if”, given the ECB's proven reluctance to reduce interest rates. And yet a stronger euro not only should make it easier for the ECB to cut rates while holding inflation down, it also should make such reductions imperative because the rise in the euro itself is equivalent to a tightening of monetary conditions.
Although manufacturers may be hurt in the short term by the euro's rise, the euro area's economy as a whole should benefit. A stronger exchange rate improves any economy's terms of trade, and so boosts consumers' spending power: they can buy more foreign goods in exchange for the same amount of domestic production. Lower interest rates will also, at last, boost Europe's feeble domestic demand, which has long been a big drag on euro-area economies. Finally, a stronger euro should force politicians and firms in Europe to pursue the kind of painful but necessary structural reforms which they have long talked about, but resisted making.
Many of the same arguments apply to Japan, where a weaker dollar is also feared. Japan's options are more restricted. It cannot cut interest rates below zero. But if foreign-exchange intervention is allowed to feed into the money supply (in effect, by printing yen to buy dollars), then this, too, would be a useful form of monetary easing.
The Japanese and Europeans may ask why they should be forced to adjust to imbalances in the world economy caused by profligate American consumers and an even more profligate American government. They should be grateful for America's profligacy: those borrowing-and-spending habits, though plainly unsustainable, have recently been the major engine of global growth. It is past time for others to do their part. The ECB, in particular, must boldly seize the opportunity presented by the euro's rise. If euro-area GDP growth now slows, the ECB will be to blame, not the rise in the dollar.
Edit- Sorry guys , I am on a roll with this.
