How the current dollar drama unfolds could end up affecting more than just the price of T-shirts at Wal-Mart or the number of German tourists visiting Yosemite National Park.
A weaker dollar, over time, could help the world economy become better balanced with America less reliant on borrowing and Asia less dependent on exports to fuel development. But realignment also holds risks. It would impose some hardship on Americans, and on the many nations that sell goods to them. A sudden shift could jolt US consumers with higher prices at a time when some economists worry about a possible recession.
"Most economists agree that in the long term, the dollar has to go down" to help shrink the mammoth US trade deficit, says Axel Merk, who manages the Merk Hard Currency Fund in Palo Alto, California. Yet in the short run, "it's in nobody's interest in the world for the dollar to go down."
The current slide may or may not persist. But when the dollar falls relative to other currencies, it tends to make US exports cheaper and, thus, more attractive on world markets. And it makes foreign imports more expensive to American consumers.
That doesn't mean the dollar's value is a magic fix for the US trade deficit, which has reached unprecedented proportions. But many economists see it as part of the answer to this imbalance in global trade.
The dollar's recent weakness continues a pattern that began in 2002. Why now and will it continue?
A weaker dollar would affect the purchasing power of Americans when they buy goods or services from other countries. The shift wouldn't be noticed at the supermarket as much as it would be at stores like Target or Best Buy. "It would mean those things that are so cheap at Wal-Mart would be a little more expensive," Engel says. "The flip side is that workers might move back toward some sort of export industries." To some degree, the trade deficit and the buoyant dollar in recent years are signs of US economic strength. Imports often surge in an expanding economy.
Still, many economists say that at some point and sooner might be better than later the trade deficit must fall.
America's deficit in the current account has surged to over $800 billion a year equal to about 7 per cent of the gross domestic product. That's up from 1.7 per cent of GDP a decade ago.
There's no precedent for a major economy to maintain this level of imbalance. The higher the imbalance goes, the greater the risk of a hard adjustment.
Exchange rates are a piece of a larger puzzle. Another factor is that the US has a low rate of savings due to federal deficits and consumer borrowing. The trade deficit mirrors this. Trade barriers in other nations are another factor.
Still, a lower dollar could play a role in resolving the imbalance.
If China allowed the yuan to rise, "the dollar would also fall against most Asian currencies," says Peter Morici, a University of Maryland economist. Falling imports would raise the US savings rate, he says.
Martin Feldstein, a Harvard University economist, has pointed out a precedent in the 1980s for a currency-driven easing of the trade deficit. As the dollar fell, the gap closed without fanning inflation or causing a recession. He said America should have a 'competitive' (lower) dollar abroad alongside a 'strong' dollar at home whose purchasing power is not eroded by domestic inflation.
By Mark Trumbull, The Christian Science Monitor
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