Tuesday, December 21, 2004

Falling US Dollar

Some notes on how the falling US Dollar might affect the world.

North America

USA
  • Borrowing over $600bn per year to satisfy its deficit
  • Imports are 50% more in value than Exports
  • It has the advantage of being the reserve currency of the world. It pay the interest on its debt in its own currency.
  • Dollar is held strong by the Asian Central Banks which are ready to buy US Dollars to prevent it from falling further. This artificial support cannot last longer if the US does not manage to narrow its deficit and increase its exports. If the US continues to borrow without trying to gradually re-align the US Dollar, it might lead to a recession if the situation worsens and the Dollar falls suddenly.
  • With the current level of trade deficit, the US Dollar would have fall about 50% from its current value to narrow this deficit. But if this happens, the standard of living in the US will be badly affected.
  • Some observers comment that the Fed can intervene and raise interest rates to strengthen the US Dollar.But such a move could affect the investment mood in the US and intensify recessionary pressures. But if the Dollar continues to fall, it will push up the interest rates eventually.
  • Some observers feel that Dollar might get stronger if the other economies of the world get stronger and increase their demand for US products.
  • Exporters who do not depend on imports might benefit for some time, but if foreign investors start taking out their investments it might lead to a fall in the US Stock markets.
Canada
  • Floating foreign exchange rate.
  • Is a net exporter to Canada. Both its imports and exports are heavily skewed towards US.
  • Canadian exports might lose preference to countries like China if the Canadian dllar keeps appreciating against the US Dollar.

Western Europe
  • European exports should face price competition from US due to the strengtheing dollar.
  • Surprisingly, European tourism has not taken a hit. UK and France are still the favourite destinations for US despite the weakening dollar.

Eastern Europe & West Asia
  • Many East European countries are more dependent on Europe for their exports. And they do not hold huge forex reserves in US Dollars. So the falling dollar should not affect these countries greatly.

East Asia

China
  • Holds over $500bn of US treasury bonds in its Forex Reserves
  • Has the Yuan pegged at 8.28 yuan to USD 1
  • Keeping the dollar strong is essential to help its export-led growth
  • Fall in US Dollar could cause an internal crisis due to unemployment issues
  • China holds the key in preventing the US Dollar from falling further. Termed by experts as the
  • "Lynchpin"
  • But China might change its stand when all its labor is employed. Even though this could be a long term prospect, China will not always want a strong US Dollar.

Japan
  • Holds over $720bn of US treasury bonds in its Forex Reserves
  • Yen is rising despite efforts by its Central bank. The rising Yen seriously affects its exports, worsening the situation at hand, where the government is fighting deflation.
  • Wants a concerted effort along with European economies to push up the US Dollar.

Others

Middle East
  • Sells oil in US Dollars. Serious crisis at hand if the US Dollar continues its fall. All the oil money which is stored in dollars is fast losing its value

Russia
  • Falling US Dollar will affect its oil revenues. It has already started moving its reserves to Euros.
Historical instances and possible future scenarios
  • In 1990s, there was a high demand for the US Dollar to invest them back into the US IT companies which were sought after by investors around the globe. But this time around, the demand for dollar is rather artificial and because of Asian central banks trying to hold their currencies from falling.
  • The direction that the bond yields will take in reaction to the falling US Dollar has to be observed. In 1985-87, when bond yields fell along with the dollar, the Fed tried to prop up the bond yields. The Fed's intervention finally led to a stock market crash.
  • The Asian economies seem to be in a weird situation. If one Central Bank decides to diversify its forex reserves and starts selling the dollar before it falls further, everyone might follow suit which might lead to a major crash in the dollar.
  • If the fall in US dollar continues, the Asian economies which depend on exports to US, might finally lose their competitiveness and would have to look to other markets. This could look far fetched at the moment but nonetheless should not be ruled out in the long run.
  • Some business models like outsourcing might come under serious question if the fall in US Dollar continues. The basic selling point of outsourcing was cheaper inputs. But this basic selling point is under threat if the fall continues.

8 comments:

kicha said...

how about the impact on india? it looks like out-sourcing
business will get affected because of the fall in US dollar.. is that due to Rupees value will increase,
and ppl in US will think that investing in india
would be costly affair?

Krishna Ram

Anand Swaminathan said...
This comment has been removed by a blog administrator.
Anand Swaminathan said...

Yep. But it depends on which country is outsourcing its work. Only US companies will find it more difficult. The Euro is still strong against the Rupee.

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