Dropping Dollar an Indicator Often Overlooked

Full article: 

Dropping Dollar an Indicator Often Overlooked

As the economy watch continues, observers are carefully monitoring consumer spending, employment, housing prices and credit markets. All of these are important indicators of whether or not we will experience a recession in 2008. Another factor that has not received as much attention is the value of the dollar. It may receive less attention because its effects are always clear.

The recent weakening of the dollar has had its benefits. Although it buys fewer units of a foreign currency than when it was stronger, foreign currency buys more dollars. When buyers from another country wish to purchase a U.S. product, they need dollars to make the purchase. When the dollar is weaker, they can purchase these dollars for less and U.S. products become cheaper. This is a boon to our exports. In 2007, exports skyrocketed and enjoyed faster growth than any time in the last five years. And while export growth reached double digits, import growth declined. Locally, major exporters, from large employers such as GE Aviation to employers that employs less than fifty people, benefit from the weaker dollar. This advantage isn’t always evident immediately because contracts often specify prices and will be in effect for many months. Most economists believe that the advantages to exporters of the weakened dollar are likely to be realized for some months after the dollar stops declining.

Just as a weak dollar make exports less expensive, it makes imports more expensive. From January 2007 to January 2008, the U.S. Import Price Index rose 13.7 percent, the largest year-over-year increase since the index was first published in September 1982. This dramatic increase in import prices raises the threat of inflation and takes away some degrees of freedom for the Fed as they search for a non-inflationary stimulus economic policy.

Another concern is the impact that a weakened dollar has on credit markets. Because of its huge budget deficits, the U.S. must borrow heavily (by selling government securities) to make up the difference between its tax revenues and spending. If the dollar is expected to continue its slide, there will be concern about the future value of these securities and foreign parties will be less interested in holding it. Currently, foreign parties hold about 40 percent of all public debt and a decrease in demand will cause the price of government securities to fall, interest rates to increase and uncertainty in international credit markets. Most economists feel that this will dampen economic growth and create a degree of uncertainty that will be a much bigger problem than the current mess created by sub-prime loans.