Down with the dollar

March 5 index value of the dollar against six other major currencies touched 89.11, its highest point this year. Since then, however, there is a steady falling dollar. Tuesday, October 20, for example, the dollar fell to 75.24, which was the lowest point in more than a year.

This is hardly a sign of collapse, and do not necessarily cause for concern. American exporters whose goods become more competitive abroad, quite pleased with the weak dollar. Domestic producers also benefit from the fact that competing imported goods become more expensive. European tourists, who can now buy more for their euro during shopping tours in the U.S., also benefited. However, long-term decline of the dollar enhances the sinister whisper in countries such as China and Russia, which hold a significant portion of their reserves in dollars and now have to think about how to translate them into another currency. Introduction Brazil 2% tax on inflows of portfolio securities - is direct evidence that other countries are nervous because of the fact that their currencies rise against the dollar.

Concerns about the dollar - the phenomenon is not new. Already long before the credit crunch, many worried that the collapse of the currency and Treasury bond yields jump accelerate the economic crisis, as well as foreigners refuse to finance the U.S. balance of payments deficit. Instead, it is the sub-prime mortgages and financial institutions with over-leveraged plunged the world into the worst recession since the Great Depression.

A recession, which reduced U.S. imports, as consumers tightened the belt tight, cut the trade imbalance by reducing the balance of payments deficit. Ironically, these processes were accompanied by new weakness of the dollar.

The simplest explanation is to reduce currency risk aversion. In the days when risky assets are falling - the dollar tends to increase. When risky assets are growing - on the contrary dollar falls. The dollar fell fairly steadily since March, just at a time when stock markets have enjoyed a phenomenal rally. Local investors were the U.S. to establish relations, returning funds to the country in 2008, when they feared the financial market conditions and to withdraw money abroad this summer, as they found that the world economy revives.

While risk aversion may be a factor, describing the U.S. as a "safe harbor" Still, this seems unlikely. Indeed, the weakness of basic nonmarket factors to revive a long bearish trend towards currency. Some refer to the U.S. budget deficit, which is expected to reach 13,5% of GDP this year. There is little confidence that the Obama administration plans to reduce it, and reform of health care can also be attributed to this.

But if foreign investors are so concerned about why the dollar's decline is not accompanied by a sharp increase in the yield on bonds? One reason may be that the Fed is buying so much debt during the year in the context of quantitative easing. This contributed to the retention of low profitability.

Maybe it works and a simple rule: supply and demand. Last year the market was in need of dollars, because investors have to meet their liquidity needs. This year, Quantitative easing (QE) creates a surplus of dollars (and pounds), and, thus, driven by both currencies down.

Using QE also creates problems for the Central Bank because they think about their exit strategy. Too early abandonment of this principle can lead to a sharp rise in bond yields, unless there is a sharp improvement in financial position. However, the continuation of QE may cause further weakness of the currency.

It is difficult to assume that U.S. authorities will try to take in order to support its currency, even if they wanted to. Low yield provides little support for the dollar. It is unlikely that the Fed will raise interest rates from almost zero in the next 12 months or so.

It is difficult to draw parallels with the history. The country, which is heavily in debt owed to foreigners, with the state budget deficit, which it creates, to move forward a little, now creates a vast amount of additional currency. Nevertheless, it is possible to maintain low interest rates. Ultimately, such a mechanism should collapse, thus creating a new currency, just as it happened in Bretton Woods in the 1940s.

Lack of probable alternative to the dollar means that, despite its declining value, its status as a world reserve currency is unlikely to be seriously threatened. But the system can be changed in other ways. A world where currencies are traded within the group or where foreign lenders require the U.S. to release some of the debt in other currencies, has all the capabilities to adapt to the decreasing dollar.

The Economist
October 20