A fading greenback

Decline in dollar has serious effects

By Stephen Dunphy: Dec. 14, 2003

    Planning a trip to England soon? It just got more expensive. Planning to export your latest upgrade of widgets to Italy. You should be able to offer an attractive price for your new product.
That in essence is what has happened in the past year or so as the dollar has declined against many of the world's top currencies. The decline has been gradual, hitting headlines this past week only because the dollar is now at a record low against the euro.
For most people, the dollar and currency flows are about as understandable as quantum physics or the new Medicare bill or why the Mariners did not re sign Mike Cameron. Like many things in economics, almost any question about the dollar is answered by "it depends."
For example, the change in the dollar against the euro is either a 47 percent gain in the euro or a 32 percent decline in the dollar since July 2001 when the rate was about 0.84 euro to the dollar. It depends on your starting point to determine the change.

Remember how all this works.  

   If you're a tourist heading for Tokyo, your expenses are up. A 1,200 yen taxi cab ride costs $10.17 when the yen is 118 to the dollar but rises to $11.01 when the yen is 109 to the dollar. Retail prices are quoted in the local currency, so the impact of any change in exchange rates is felt most by people spending money in the domestic economy. Cab fares, hotels and restaurants all cost more.
On the business side, things improve, at least from the point of view of an American company that exports. A U.S. company selling an industrial pump to a company in Germany with a list price of $98,000 suddenly is very competitive. Two years ago, the German company went to its bank and took out 117,168 euro to cover the $98,000 price. Last week, it took only 79,968 euro to buy the same $98,000 pump.   A German competitor may have priced his pump at 110,000 euro two years ago to be competitive against the U.S. company. His pump probably still costs 110,000 euro. The U.S. company is able to offer a 32 percent discount without doing a thing.
Of course that's what has Europe concerned and talking about imposing currency controls. That would limit the price movement in the euro, perhaps rolling it back to a price that would be set by the central bank.  Not exactly a free market solution.   Europe, however, gets hit with a double whammy on currencies. Because the Chinese yuan is linked to the dollar, the Chinese currency has devalued more than 30 percent against the euro, too. That means already cheap Chinese imports are even cheaper, hitting domestic European producers particularly hard.
A weakening dollar   or a rising euro   does several things. It makes exports from European companies more expensive relative to U.S. ones. The products of U.S. companies become relatively cheaper. The shift results in creating more exports and curbing imports, reducing the trade deficit. At least that's what the textbooks say.  The deficit is a problem that needs to be addressed. The current account, a wider measure of trade than the monthly merchandise report, now has a deficit that is 5 percent of gross domestic product. It means the U.S. must borrow $2 billion a day to "balance" trade accounts.
In Asia, central banks are worried that a weaker dollar will slow the limited economic growth they have seen over the past year. So Asian central banks have been investing the dollars flowing into their economies back into U.S. assets, mostly government bonds.  Recent reports note foreign central banks hold more than $1 trillion in U.S. bonds. That's more than the Federal Reserve's own bond portfolio, which is worth about $660 billion. Reuters reported that foreign central banks took up as much as a third of U.S. Treasuries auctioned last month.
What's likely to happen and does it matter?  Most experts say the dollar probably will continue to weaken. Japan last week intervened in currency markets to the tune of billions of dollars to stem the fall in its currency. Still the yen is at 108 to dollar with little sign it is weakening.
  Europeans are very worried about the euro/dollar relationship. In some ways, they don't understand why it is happening. The U.S. economy grew at an annualized rate of more than 8 percent in the third quarter; Europe's grew less than 1 percent. Under that formula exchange rates should be going the other way.
  The problem these days is that investors are now worried about the rising U.S. trade deficit and the growing federal government deficit. Both eventually come home to roost in the economy, often in ways no one wants.
  One way to help the situation would be to make dollar assets more valuable. One possibility would be to raise interest rates. The Federal Reserve could be forced into a situation where it raises interest rates at the wrong time for the economic recovery, choking off the growth.
  And currency rates matter. In an economy where many jobs are tied to trade, exchange rates are important. Remember the textbooks   a weaker dollar should boost exports, curb imports and reduce the trade deficit.
  The big question on the minds of many is whether exchange rates work the way they once did. As companies become more global they are increasingly able to match costs and currencies around the world. It means that the textbooks might be wrong.

Stephen H. Dunphy's columns appear Tuesdays Fridays and Sundays. Phone: 206 464 2365. Fax. 206 382 8879. E­mail. sdumphy@seattletimes.com. More columns at www.seattletimes.com/columnists

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