Quick Study: Dollar Doldrums

What a weak dollar means to you.
By Harry Hurt III
From Reader's Digest

 

The dollar's long slide began in 2002; since then, it has lost nearly half its value versus the euro.

The Declining Dollar
Sure, your dollar buys less today than it did a year ago. Your shopping cart and your gas
gauge have both been telling you that for months now. What's shocking is how fast and how far the dollar has fallen.
In the 12 months between June 2007 and June 2008, the dollar lost nearly 15 percent of its value. That's compared with the euro, the currency used by Germany, France, Italy, and 12 other European countries. Since 2002, the dollar is down 40 percent versus the euro.

Illustrated By Arthur Mount
The dollar's long slide began in 2002; since then, it has lost nearly half its value versus the euro.

A weaker dollar can help American manufacturers, but it means higher prices for imported goods-from everyday items like clothes to major purchases like cars. Where it really hurts is at the gas pump and the grocery store. The decline of the dollar is one reason we're paying more than $4 for both a gallon of gas and a gallon of milk.
Who determines how much the dollar is worth? The policies of the U.S. Federal Reserve Bank (those dollars in your wallet are Federal Reserve notes) and the central banks of other countries have a lot to do with it. But the day-to-day price of the dollar is set by foreign exchange (FX) traders, who buy and sell dollars and other currencies. The roster of FX traders includes major banks, multinational corporations, and wealthy individuals in the United States and in nearly every country around the world.
The daily volume of the FX market is $3.2 trillion, roughly ten times the daily volume of all the world's stock markets combined. Currency trading occurs 24 hours a day, seven days a week. Exchange rates between the dollar and other currencies are like a national financial review-the FX market gives the dollar a thumbs-up or thumbs-down. Over the past six years, the dollar has repeatedly gotten a thumbs-down.
U.S. policymakers now face a dilemma. Should they try to strengthen the dollar? Or will a weaker currency help the economy in the long run?
What Turned the Dollar Into 63 Cents:
Budget deficits - The U.S. government has spent more money than it has received in every year since 1971, with the exception of 1998 to 2001. Last year, the federal deficit was $162 billion. As of 2007, the national debt was $9 trillion, more than $2 trillion of which was owed to foreign investors.
Trade deficits - Since 1975, the U.S. has been spending more money to buy foreign imports than it has been taking in from selling American exports. The U.S. trade deficit (total imports minus total exports) is currently averaging almost $60 billion a month, or more than $700 billion a year.
War spending - No one knows how much the U.S. government will ultimately spend in Iraq and Afghanistan; estimates run as high as $1 trillion. Many economists agree military spending increases the budget deficit and contributes to the rising prices of strategic commodities like oil.
€ vs. $ - By some measures, the European Union surpasses the U.S. in economic power. In 2007 the total annual economic output of the EU was $14.7 trillion, compared with $13.8 trillion for the U.S.; the EU economic growth rate was 3.1 percent versus 2.2 percent for the U.S.

• Flash Points

• Strong dollar: What's good - A strong dollar is the equivalent of a vote of confidence by the FX market in the economic and political future of the U.S. For Americans, foreign imports are relatively inexpensive, interest rates remain low or moderate if inflation is controlled, and the standard of living is relatively high.
• Strong dollar: What's bad - A strong dollar makes American-made goods relatively expensive for foreigners. Consumers at home and abroad buy less costly goods from countries other than the U.S. Sales of U.S. companies erode, prompting them to lay off American workers and outsource jobs to countries with cheaper labor.
• Weak dollar: What's good - A weak dollar makes American-made goods and travel to the U.S. less expensive for foreigners, boosting the sales of U.S. manufacturers and prompting them to increase production and hire workers. The growth of U.S. exports helps trim the trade deficit. A weak dollar also attracts increased foreign investment in U.S. real estate and capital markets.
• Weak dollar: What's bad - A weak dollar makes foreign imports and overseas travel more expensive for Americans; the U.S. standard of living falls because the dollar buys less. If traders believe the dollar will continue to weaken, they may invest in stronger currencies of other countries.
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• The Back-and-Forth
• "The U.S. dollar has been the world's reserve currency since World War II [with] good reason … The U.S. has the largest, most open economy in the world, and our capital markets are the deepest and most liquid."
• --Henry M. Paulson, U.S. Secretary of the Treasury, June 2, 2008
• "Now the dollar is being ridiculed in overseas markets. Henry Paulson and Ben Bernanke [should act] to strengthen the dollar and bring down the rate of inflation so people can afford to buy oil and food again."
• --Lawrence Kudlow, syndicated columnist and host of Kudlow & Company on CNBC
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• 'The way to strengthen the dollar is to strengthen the economy … to invest in our infrastructure … roll back those Bush tax cuts, end this war, and get our budget in balance.'
• --Senator Barack Obama April 10, 2008
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• "The U.S. should [try] to reduce barriers to trade, level the global playing field, and build … enforcement of global trading rules. These steps would also strengthen the U.S. dollar."
• --Senator John McCain, posted on johnmccain.com
• Forward Thinking
• Reports of the dollar's demise may be premature - Despite losing 40 percent of its value versus the euro since 2002, the dollar still plays a role in 90 percent of all foreign exchange transactions. Oil, for example, is still priced in dollars. Continued use of the dollar as the world's reserve currency-the dominant monetary unit used in international transactions-eliminates transaction costs associated with converting one currency into another.
• Euro expansion - Remember, only 15 of the 27 European Union member states use the euro; if the other 12 adopt the euro, the population of the euro-using area will soar to more than 495 million people. Some economists and commentators say the dollar will eventually lose its supremacy as the world's reserve currency. One such scenario foresees a world divided into trading blocs dominated by the dollar, the euro, and perhaps the Chinese Yuan.
• China's economic boom is just beginning - China is already the world's third-largest economy; its population of more than 1.3 billion people is nearly twice that of the U.S. and the EU combined. But China's gross domestic product per capita (its annual economic output divided by population) is still only $5,292, compared with $45,845 for the U.S. and $32,938 for the euro-using area, which leaves China with enormous potential for growth.

 

• The Timeline
• 1792
• Congress passes the Coinage Act, establishing the dollar as the monetary unit of the United States.
• 1861
• Congress authorizes printing of paper money to fund the Civil War; one-dollar note bears likeness of Treasury Secretary Salmon P. Chase.
• 1862
• Bureau of Engraving and Printing founded in Treasury basement.
• 1869
• George Washington first appears on a one-dollar bill.
• 1913
• Congress passes Federal Reserve Act, establishing central bank to reduce likelihood of financial panics.
• 1929
• U.S. currency reduced in size by one-third; portraits and designs still in use today are adopted.
• 1933
• In midst of Great Depression, Congress passes Emergency Banking Act, intended to restore confidence in paper money.
• 1944
• Bretton Woods Agreement establishes dollar as world reserve currency (money used for international transactions); paper notes can be traded for gold bullion at a rate of $35 to one ounce of gold.
• 1955
• As Cold War statement, Congress orders "In God We Trust" to appear on all paper currency.
• 1969
• Circulation of $500, $1,000, $5,000, and $10,000 bills stopped; $100 bill now largest in circulation.
• 1971
• President Nixon takes dollar off gold standard because foreigners hold more U.S. paper currency than U.S. has gold bullion.
• 1974-1979
• Oil embargo by OPEC states and runaway inflation weaken dollar; dollar loses 10 percent of its value relative to other world currencies.
• 1997
• Dollar begins surge in value during period of economic growth and international stability.
• 1999
• European Union introduces euro for use in business transactions; EU begins issuing euros for consumer use in 2002.
• 2001
• Dollar remains temporarily strong despite 9/11 attacks.
• 2002
• Bear market begins; dollar eventually loses 40 percent of value.
• 2003
• Dollar continues slide as foreign economies rebound and concern grows over U.S. trade deficit, war spending, and oil supplies.
• 2008
• Dollar hits all-time low (€1=$1.60) on April 22; Treasury Secretary Henry M. Paulson (left) reiterates commitment to dollar as world reserve currency. Fun fact: What $1 bought in 1792 now costs $22.37.