The U.S. Dollar Index is approaching its all-time low, but a number of factors may signal a rebound for the greenback. Image: Flickr/iChaz CC-BY-SA

Continuing a prolonged slide, the U.S. dollar fell in value to nearly its lowest level since August 2008 Tuesday against the currencies of major U.S. trading partners. Analysts say that Federal Reserve policies of low interest rates and billions in bond purchases, plus international worries about the U.S. debt situation are keeping the dollar down. Analysts also say that much like interest rates, what goes down must eventually come up and the U.S. dollar could be a profitable long-term investment.

Inside the U.S. Dollar Index

The U.S. Dollar Index (USDX) has fallen 2.7 percent in April and 6.6 percent so far in 2011. The USDX is a measure of the value of the U.S. dollar weighted against a basket of foreign currencies that includes the euro, pound sterling, Canadian dollar, Swedish krona, Swiss franc and Japanese yen. Upon its inception in 1973, the USDX was 100.000. In February 1985 it peaked at 148.1244. On March 16, 2008, the USDX hit an all-time low of 70.698. On Monday, the USDX fell as low as 73.744. Other currencies have been rising at the dollar’s expense. The euro has gained more than 9 percent this year and hit $1.4639 Monday. Despite the earthquake, tsunami and nuclear disaster in Japan, the yen has gained about 2 percent on the dollar in April. The pound sterling has gained 5.4 percent on the dollar in 2011.

Greenback destined to get weaker

The dollar could get even weaker in the next few months. Analysts expect that the Fed, which convened the Federal Open Market Committee Monday for a closely watched 2-day rate-setting meeting, will maintain a loose monetary policy consisting of interest rates near-zero and quantitative easing, the controversial bond buying program. There is also growing concern in the rest of the world that partisan bickering will preclude the U.S. government from adequately addressing the huge federal budget deficit. Those concerns were made tangible a week ago when the Standard & Poor’s rating agency lowered it’s outlook for U.S. debt. A weak dollar has been padding the profits of U.S. multinationals such as IBM, Coca-Cola and Procter & Gamble, but the spending power of U.S. consumers is being eroded. In a response to a question about how the Fed has hastened the dollar’s decline, Treasury Secretary Timothy F. Geithner told the Council on Foreign Relations in New York the U.S. is committed to a strong dollar and the U.S. won’t weaken its currency to gain an advantage over its trading partners.

The case for a strong dollar

The U.S. Dollar Index is currently only 5 percent higher than its all-time low from March 2008. But also like 2008, oil and gas prices could soon peak because those higher prices are destroying demand, especially in developing markets. If that happens, the dollar could rally as commodity prices fall. Plus, any hint the Fed will raise rates will boost the dollar. Some analysts believe the Fed will start raising interest rates slowly later this year. Today, many currency fund managers are actively shorting the dollar. But if the dollar starts to recover, those funds short the dollar may be forced to cover their positions and the greenback could rally once again.

Sources

MarketWatch

CNNMoney.com

Bloomberg

Wikipedia

It was designed to break your heart. And its falling value has an impact on all our lives. (Photo: flickr.com)

Under both the Bush and Obama administrations, U.S. government spending – financed by government borrowing – has skyrocketed, resulting in a prolonged decline of the value of the dollar. This trend escalated with the Federal Reserve’s reaction to the 2008 subprime mortgage crisis and the dramatic drop in interest rates. Today, with interest rates still low and government borrowing still rising, the dollar continues its steady decline. Recently the dollar has reached new all time lows against the Euro and other major currencies resulting in a lot of concern about the dollar’s viability internationally. It has even been argued in some quarters that the United States may have its national credit rating lowered.

Does it Really Matter to Most Americans?

Economic optimists point out that most Americans do not travel abroad for significant periods of time, meaning that currency conversion rates do not matter to them. They also argue that a weak dollar helps the economy by stimulating American exports. Both of these arguments are valid, but they fail to take into account the ways that a declining dollar does affect the domestic economy. While your average American may not have to worry about converting his cash into euros, your average American does buy a lot of imported goods and though the weak dollar does help exports, exports constitute less than 15 percent of the Gross Domestic Product (GDP), so only a few benefit.

The Weak Dollar and the Cost of Imports

Goods that are imported into the United States, even if the trade is denominated in dollars, are directly affected by the value of the dollar. The weaker the dollar is, the less value it has abroad, so those countries exporting to the United States have to increase the price to compensate for this. Among the most vital of these imports is oil, upon which the United States is largely dependent. A weaker dollar means that oil and all of its derivatives increase in price. The same can be said for all imported goods, from clothing and textiles to components in ostensibly “American-made” products. The lower the dollar, the more expensive all imported goods are to the average American consumer.

Dollar Value and Foreign Investment

The United States has been heavily reliant on foreign investment for decades now. Foreign investment in government debt is what keeps the federal government solvent. Similarly, foreign investment in our financial system – banks, major corporations, securities markets – is also essential to keeping the economy sound and money circulating through the system. However, since virtually all of these investments are denominated in dollars, a declining dollar discourages foreign investment. Since the U.S. requires this foreign investment, the logical answer is to make American investments more attractive by increasing the interest rates, but this significantly hurts domestic debtors.

Yes, the Declining Value of the Dollar Does Matter

Although most Americans do not have to worry about directly converting their dollars to foreign currencies, virtually all Americans do have to deal with the increased price of imported goods, from gasoline to running shoes. The point that the weak dollar helps American exports is also valid, but the export sector amounts to less than 15 percent of the economy, whereas the more expensive imports affect virtually all Americans. Further, since the government and financial industry have to encourage continued foreign investment, it means that interest rates are likely to increase, putting increased pressure on domestic debtors, from mortgage holders to people with large credit card bills.

Is There Anything You Can Do About This?

The factors behind the declining dollar are macroeconomic in nature and the key player, the Federal Reserve, is not directly accountable to the public. Those with large investment portfolios may want to consider diversifying some of their holdings into assets denominated in other currencies to serve as a hedge, but this is only an option for a minority of Americans. There may also be some value in investing your retirement and savings in international mutual funds, those based on foreign assets. Otherwise, there are few options available to your average American. Nevertheless, it is important to understand that the declining dollar does directly impact you.