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
Scary reality
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