Meltdown 101: What would be better for the economy right now -- a stronger or weaker dollar?
Would the U.S. economy be better off if the mighty dollar weren't so mighty?
The dollar has strengthened against most other major currencies for much of the second half of the year. It recently reversed course, but the big picture remains the same: The Thomson Reuters U.S. dollar index, which measures the dollar's value relative to the euro and the Japanese, Canadian, British, Swedish and Swiss currencies, is still up more than 10 percent from its lows in March.
All the while, the economy has been wallowing in a deepening recession.
Does the strong dollar have anything to do with the nation's economic woes? What would be better for the economy right now -- a stronger dollar or a weaker one?
Here are some questions and answers about the strength of the dollar:
Q: Should we be rooting for a stronger or weaker dollar right now?
A: In a broad sense, a weak dollar is probably favorable while the economy is ailing, since it would make U.S. goods cheaper to consumers outside the country.
"The dollar is really a shock absorber," says Brian Bethune, economist at IHS Global Insight. "When domestic economic conditions are weak, it goes down to stimulate demand for U.S. product overseas."
Q: So why have we seen such dollar strength in recent months?
A: The dollar, which had already been on a multiyear losing streak, began to weaken further in late 2007 and early 2008 as it became clear the U.S. was heading into a recession. But as the global economic outlook soured, investors flocked to the safest assets around: U.S. Treasury bills, notes and bonds. (In other words: investments in U.S. government debt.)
Because Treasury investments are denominated in dollars, this trend pushed up demand for greenbacks -- and more demand translates into a stronger dollar.
Q: How has that hurt the U.S.?
A: The stronger dollar has come at a bad time. It made U.S. goods more expensive overseas as the economies of many major U.S. trading partners are mired in recession. That has weakened the demand for U.S. goods, which has caused exports -- a rare bright spot in the U.S. economy earlier this year -- to fall hard.
The drop in exports could lead to more job losses, at a time when employment is already declining at the fastest pace in decades.
Q: But doesn't a strong dollar help by making imports cheaper?
A: Yes, and we've seen import prices fall hard, too. Especially for one of the country's favorite imports: oil.
Some economists think declining imports will outpace what we're losing in exports, narrowing the trade deficit. That could add to gross domestic product -- the broadest measure of the nation's economic health -- and help the economy.
But in October -- the latest month for which data are available -- exports fell at a greater rate than imports, and dollar strength was one reason why. The trade gap widened to near record levels.
Q: What about the impact on U.S. businesses?
A: It depends on how much of a company's revenue comes from outside the U.S.
For a multinational company like Nike, for instance, their goods become more expensive overseas as the dollar strengthens, which could give their competitors an advantage. For companies that sell most or all of their products in the U.S., such as Family Dollar, a stronger dollar is good for the bottom line, because there's more buying power in each dollar the company earns.
Many companies have been lowering their profit outlooks due to the dollar's second-half strength, as the same amount of sales overseas translate to fewer dollars than in previous quarters.
Q: What are the positives of a stronger dollar?
A: The risks of inflation subside, and that's normally a good thing. Right now though, inflation is less of a worry than weak growth.
Still, there's a bright side: Low expectations for inflation have made it easier for the Federal Reserve to lower interest rates to help spur the U.S. economy -- a move that usually carries serious inflation risks.
Q: What's better for the U.S. consumer?
A: There are several ways a stronger dollar can benefit regular folks.
First, the foreign goods we buy -- like cars or handbags -- become less expensive. Those who invest abroad, even through mutual funds, can get better values on assets. It also makes it cheaper for Americans to travel abroad, and it can also boost consumer confidence, if workers feel their paychecks are stretching further.
Of course, all those benefits become moot if you lose your job because your multinational employer -- struggling to compete overseas because of a strong dollar -- has to resort to layoffs.
Q: There have been recent stretches when the dollar turned the other way and weakened. Why did this happen?
A: The Fed has cut its target interest rate to close to zero and it's vowed to take further steps to keep rates low. That sends a signal to investors that the U.S. economy remains in dire straits, and it gives investors less of an incentive to hold interest-bearing investments denominated in dollars. Reduced demand for such investments can push the value of the dollar downward.
Key short-term interest rates in the U.S. are among the lowest in the world's industrial nations -- on par with Japan, which has fought for years to keep its rate low.
Q: What should we expect in the near future?
A: There are many variables that make predicting currency strength a near-impossible task, but some analysts and traders suggest the stage is set for a return to weakness against other major currencies, especially if other industrialized nations are less aggressive in cutting interest rates. Also, if the Fed continues to pump dollars into the economy, as it's promised to do, the increased supply of the currency could push the value of the dollar further downward.
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