When the US Dollar eclipsed its previous record low against
the Euro last week, commentators immediately began painting doomsday scenarios
for the beleaguered currency. On paper, the argument for a continued decline in
the Dollar is quite strong, due to a sagging economy, surging current account
deficit, the prospect of lower interest rates and turmoil in US capital
markets. But, in practice, the Dollar remains the world’s de facto reserve
currency, which begs the question: “how much-if at all-will the Dollar decline?â€
Let’s begin by examining the state of the US economy. At this point, economists have clearly
identified the housing/real estate sector as a major weakness in the US economy. Instability and an overall lack of demand have
contributed to falling prices for real estate, which is eating into consumers’
disposable income, and hence threatens to bring down the rest of the economy. In fact, the most recent employment data, which
has become the most-watched piece of economic data in recent years, signaled
that for the last 3 months, no new jobs were created in America, which
is a tremendous cause for concern.
As a result, it is all but certain that the Federal Reserve
Bank will lower its benchmark interest rate at its next meeting, perhaps by as
much as 50 basis points. While this may
soften the impact of the sagging housing market on the rest of the economy, it
will also decrease the EU-US interest rate differential to only 75 basis
points. In addition, the European
Central Bank will likely raise rates at its next meeting, which means the
differential will be further reduced. Combined
with general instability in US capital markets, brought on by weakness in
mortgage-backed securities, foreigners are beginning to grow wary of investing
in the US.
While a US economic recession would decrease imports and perhaps stem the growing trade
imbalance, foreigners may still decide that it is too risky to continue financing
the US trade deficit.
On the other hand, many Dollar bulls insist (correctly) that
the Dollar remains the world’s reserve currency, and serves as a safe haven in
times of global economic instability. And
in fact, the Dollar initially appreciated in value despite the turmoil in its
securities markets. However, this upward
trend seems to have been the result of a temporary shunning of risk, and since
then, the Dollar has resumed its fall. In
short, both in theory and in practice, the evidence suggests that the Greenback
can still fall much further against the world’s major currencies.
Original post by Jimmy Atkinson and software by Elliott Back
— 
— 
— 
— 