The Weak Dollar Has Pros And Cons

February 2, 2004
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GRAND RAPIDS — The depreciating value of the dollar against the euro and other major foreign currencies has some people worried.

But there’s a silver lining to the dollar’s decline — at least for domestic exporters and manufacturers.

The dollar’s slide against the euro has helped the U.S. economy by making U.S.-produced goods cheaper in Europe and European imports more expensive in the states.

So the weak dollar stimulates domestic export activity and supports manufacturing here.

And when imports are more expensive, U.S. consumers tend to substitute them with domestic goods, observed Hari Singh, Ph.D., chair of the economics department of Grand Valley State University’s Seidman School of Business.

Not only does depreciation of the dollar make U.S. exports more competitive, it helps bridge the country’s current account deficit — the difference between the country’s savings and its investments.

“The self-correcting mechanism is already there in place and it’s working right now," Singh noted.

National City’s Chief Economist Richard DeKaser said the expectation is that the trade deficit, which has been widening steadily for a decade, will either stop widening or eventually narrow because U.S. exports are more attractive in world markets and foreign imports are less attractive in U.S. markets.

The weak dollar has really been the spark that has brought the manufacturing sector back, said Mitch Stapley, Fifth Third Investment Advisors chief fixed income officer.

“If the export mini-boom we’re in gets some traction and goes, we will continue to correct that imbalance in the U.S. current account deficit.”

As Stapley put it, the United States is dealing with the long-term phenomenon of too low of a national savings rate and being too dependent on foreign investors to fund its economic growth.

The fact that the United States is still importing a lot more than it’s exporting — and has a $500 billion budget deficit to boot — makes the country very reliant on overseas investors willing to put their yen, drachma and euros into dollar-denominated assets, Stapley said. He noted that about $1 billion a day in foreign investment is needed to keep this country going.

The United States’ record trade and budget deficits are not the sole determinants of the value of the dollar, but do influence the exchange rate, DeKaser added.

“When the U.S. economy invests more than it saves, which has been the case, we have to make up for that saving deficiency by borrowing from overseas investors.”

The biggest holdings of U.S. Treasury securities right now are with foreign investors, such as foreign central banks and corporations.

The risk is that foreign investors will decide that U.S Treasury securities are not a good trade and will begin to demand a higher interest rate to hold those securities, Stapley said.

Or they could start pulling out of those investments, which, in turn, would cause the dollar to fall further, which, in turn, would cause them to pull away further.

In that case, he said, the Federal Reserve would be forced into the position of having to raise interest rates to whatever level it takes to, essentially, defend the dollar and stem the sale of those securities.

“I can’t tell you what that level is,” Stapley said. “If the yield on the 10-year treasury today is 4 percent, does it have to go up to 5 or 6 percent to attract capital again? We don’t really know.”

Foreign investment is still coming into the United States, but just not as readily as it has in the past, DeKaser said.

“We’re continuing to get the same volumes from them, but they’re demanding cheaper prices. We’re having to give them more to attract their savings.”

Stapley, too, has seen a little bit of slackening of foreign investment in the United States, but said that people seem to be betting that the U.S. economy is going to grow more strongly than the rest of the world this year.

Singh, too, hasn’t seen any dramatic reduction in demand for U.S. assets. He doesn’t believe that’s a significant risk right now.

Gradual shifts in currency valuations allow a country’s manufacturers and consumers time to adjust, Stapley said.

It’s the massive, sharp movements in currency valuations that lead to higher inflation, higher interest rates, slower growth and generally adverse outcomes for the global economy.

“We think we might see some additional dollar weakness through the middle part of the year but as we move into the third and fourth quarters of this year, the relative growth rate in the United States vs. the rest of the world is going to begin to help strengthen the dollar.”

Singh said it’s always difficult to predict where exchange rates are going to go.

“My sense is that it’s not going to change a whole lot. It might go a little bit lower or might go a little bit higher,” he said.

DeKaser believes the dollar has gone from overvaluation two years ago of roughly 15 percent to 20 percent to what it is now, which in his opinion is a very fair value.

“My guess is that we'll see the dollar move into further decline in 2004 simply based on this historical observation that the dollar almost never resides at fair value,” he said. “It tends to be prone to these cycles, which seem at this point not to have been fully completed.”

Even in its current “weakened” state against the euro, the dollar is still pretty mighty.

“Our platinum-titanium bullet is that we’re still viewed as the world’s safe haven,” Stapley said.

“In times of political turmoil, terrorism or whatever, the dollar is the ultimate, secure, risk-free investment. At the end of the day, it’s still viewed as the place — the currency — where investors go for safe haven.”           

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