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Following the Dollar DeclineRecent headlines have been in an uproar over the state of the dollar. The issue hit a crescendo in November when Federal Reserve Chairman Alan Greenspan warned that America must address issues related to the dollar’s decline, such as the nation’s trade and budget deficits.1 Even if you rarely travel abroad or exchange dollars for foreign currencies, don’t be lured into thinking the strength of the dollar doesn’t affect you. Stock and bond investors will want to pay close attention as Wall Street makes the dollar its latest obsession. In the coming months, the dollar
will be the center of attention. Some argue a weak dollar is bad; others say
it’s good for the U.S. economy. And some of the loudest complaints about
dollar weakness are coming Regardless of what side of the debate you are on, it’s important to understand why the dollar is weakening, who benefits from a weak dollar, and the potential long-term implications. Why Weakness? There are many reasons blamed for the weakening dollar, which in October had fallen by about 15% against a basket of currencies from its February 2002 peak.2 Here are some of the more popular suggestions: • U.S. trade deficit Not All Bad A weak dollar isn’t necessarily bad news for the stock market — as long as the decline is orderly and slow. U.S. manufacturers tend to applaud a weaker dollar. It makes U.S.-made products more competitive in foreign markets. Foreign consumers have more purchasing power because their currencies are stronger in relation to the dollar. The weaker dollar also drives up the cost of imported goods, which can benefit firms that use U.S.-sourced materials. When domestic manufacturing firms experience sales growth, they may be more likely to hire employees and purchase equipment in pursuit of further growth. Tourism also benefits from a weaker dollar. Foreign tourists and companies are more likely to visit because their currencies can buy more here. It can also encourage American tourists to spend their vacations dollars closer to home because dollar weakness makes overseas travel more expensive. Top Concerns Although a rapid fall in the dollar is unlikely, it could produce some tough side effects for the bond market. For example, foreign investors own about 43% of U.S. Treasury securities and 24% of corporate bonds.3 When the dollar is in a downtrend, foreign investors may be less likely to buy U.S. debt because the return may be eroded when weak dollars are converted back to their own currency. As a result, bond investors want to be compensated for the added risk of a weaker dollar. This could lead to higher interest rates in order to attract investors. The result could be more expensive capital for U.S. companies, which could slow sales growth and possibly cause stock prices to fall. Oil is also becoming a concern because oil contracts are priced in dollars. When the dollar is less valuable, oil producers are forced to seek more dollars for their oil, which puts upward pressure on oil prices. And because oil is priced into most goods or services sold in the United States, higher oil prices could mean higher consumer prices across the board. This all might sound somewhat ominous, but the situation isn’t as serious as some are making it out to be. Even Greenspan, who sounded the warning that sparked all this attention, did not say he foresees a crisis in the markets. There is still evidence of strong foreign demand for U.S. assets, he said.4 You’re going to see, hear, and read much more about the dollar in the coming months. It’s important to keep the debate in perspective and avoid making any sudden decisions based on the headlines. 1, 4) CNN Money, November
19, 2004 |
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