Vision - September/October 2007 - (Page 6) The ecOnOmiST analyzing future trends ] • [ by shawn g. dubravac, cfa T The Declining Dollar “Coupled with strong foreign economic growth and rising global wealth, a declining dollar should bolster U.S. exports—a boon for U.S. companies.” he great Yankee catcher Yogi broad 36-country trade-weighted foreign Berra—perhaps better noted exchange rate through the end of 2008. for his colloquial use of the During the last year, the dollar has English language than his 15 declined relative to almost all major curAll-Star game appearances rencies and is down 4.3 percent against or three MVP awards—is credited the nominal 36-country tradewith having said, it’s tough to make weighted foreign exchange rate. predictions, especially about the Through fits and spurts, the dolfuture. This applies to forecasting lar has followed a downward trend and especially foreign exchange rate during the last five years—falling movements. 34 percent against the Canadian While there have been many dollar and nine percent against noteworthy investors showing great Shawn G. DuBravac the Japanese Yen from highs set in acumen at successfully projecting future 2002. Relative to the Euro, the U.S. dollar exchange moves, the former Chairman is off nearly 40 percent from a high set in of the Federal Reserve, Alan Greenspan 2000. The U.S. dollar has even fallen eight once suggested there was little more than percent against the Chinese Yuan since the luck involved in these victorious calls and time China loosened the trading bands for implied these ‘successful investors’ were the Yuan in July 2005. akin to winners of childhood coin-tossing Net capital inflows during the late 1990s contests. and through 2001 were sufficient to finance Behind the backdrop of a tongue-in-cheek U.S. current account deficits, but since 2002 coin flip, I expect the dollar to decline rela- capital inflows have been insufficient to tive to most major foreign currencies over finance the current account deficit. This has the next 18 months. I project the dollar will caused the current account deficit to exert fall an additional 3.8 percent against the pressure on the dollar exchange rate relative to other major currencies. This pressure will 36-Country Trade-Weighted Foreign Exchange Rate continue as strong foreign economic growth 140 and higher yielding 130 investments outside of the U.S. compete for 120 capital flows and con110 tribute to a lower dol100 lar during the next 18 months. 90 The interest rate dif80 ferential between interest rate investments in 70 the U.S. and abroad is 60 both slowing capital ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 inflows and driving domestic investment Source: Federal Reserve, CEA abroad as U.S. inves- tors seek higher returns. Lower net capital inflows will continue to put pressure on the dollar until the differential between interest rates in the U.S. and abroad narrow through either lower yields abroad or higher yields in the U.S. Now that much of the market has finally abandoned the notion the Federal Reserve would ease monetary policy and cut rates this year, a risk to our exchange rate prediction is higher yields in the U.S. A change in expectations over the last two months has in turn driven longer-term rates like the 10-year Treasury higher— narrowing the interest rate differential and offering support to a stronger dollar. However, U.S. rates are not expected to accelerate to the point where yields in the U.S. attract large capital inflows and result in support for the dollar value relative to other currencies. The exchange rate scenario currently playing out carries more significant ramifications than a suggestion to visit Las Vegas if you want to see Paris this summer. Coupled with strong foreign economic growth and rising global wealth, a declining dollar should bolster U.S. exports—a boon for U.S. companies. A declining dollar also has implications for foreign firms. When the dollar depreciates it is typically accompanied by a rise in the dollar price of imports into the U.S. market as foreign firms adjust prices in order to maintain margins. If firms importing into the U.S. wish to maintain market share instead of margins they will be forced to forego raising prices which could hinder financial health for foreign based firms importing into the U.S. While the decline remains gradual, Yogi Berra would surely remark that “a nickel ain’t worth a dime anymore.” And though “it’s tough to make predictions,” underlying fundamentals plainly point to a weakening dollar over the next 18 months. • www.ce.org September/October 2007 http://www.ce.org
For optimal viewing of this digital publication, please enable JavaScript and then refresh the page. If you would like to try to load the digital publication without using Flash Player detection, please click here.