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Dollar Daze

The almighty dollar set off some alarms earlier today when it fell to a new low against the euro. Increased speculation of an interest rate cut, and fears that subprime lending woes will have a much larger impact on the broader U.S. economy, helped pressure the U.S. dollar. This comes after last week’s more than 1% decline against the euro and the yen in response to Wall Street’s two largest rating agencies signaling that subprime market problems will probably get worse. The dollar is losing ground against other currencies as well. Today, the British pound soared above $2.05 for the first time in 26 years today. And on Monday, the Canadian dollar reached 96 cents per dollar, closing in on parity. According to MarketWatch today, Bear Stearns economist David Brown said in a note to clients that, “The dollar continues to plumb new depths against most currencies and the slide is not about to stop here. Tensions in markets such as housing and corporate credit seem to be weighing on the dollar.” In addition, Ashraf Laidi, chief foreign exchange strategist at CMC Markets in New York, told clients that, “The dollar resumes its broad sell-off as [Fed Chairman Ben] Bernanke’s speech and the Fed’s central tendency forecasts present no real deviation in the existing negative dollar flows, which have escalated in the Asian session following Bear Stearns’ announcement on its sub-prime hedge funds.”

Differences in long-term interest rates have also played an important role in the U.S. currency’s decline. Money flows to the currency of the country with the highest interest rates and greatest security. In the past, foreign investors have chosen the U.S. dollar for its safety and returns. However, the difference in

interest rates between the United States and Europe has been narrowing, prompting the dollar’s decline as investors become increasingly concerned about the United States’s trade and budget deficits, and the potential of an economic slowdown brought on by a housing recession. Many believe European rates will eventually rise and U.S. rates will fall, extending the dollar’s slide.

The value of the dollar affects everything from the price of consumer electronics and clothing, to mortgage rates and the job market, and to whether a vacation overseas is more affordable for Americans or Europeans. If foreign investment in U.S. bonds and equities in the United States suffers as the result of a declining dollar, that could force up yields on government bonds, because higher rates would be needed to attract these overseas investors (who, by the way, make our massive twin deficits possible!). And bond yields have a direct impact on a wide variety of interest rates paid by consumers and businesses. Many goods produced overseas with no domestic competition could cost more here. And if Americans keep on buying imported goods, this could lead to an even larger trade deficit and dollar decline. In addition, American companies that buy raw materials and parts overseas would see their costs rise in dollar terms. This has the potential of cutting into profits (if they can’t raise prices) and eventually hiring. Finally, Americans traveling abroad would find prices for just about everything higher.

There is a silver lining with a weak dollar, as many big U.S. companies get a boost in overseas sales, where their products become more competitive. Economists believe this benefit should offset inflationary pressures caused by higher import prices. But if the dollar were to plummet, long-term Treasury yields could soar. “Profits would go south, and stocks would plunge,” according to Moody’s Investors Service chief economist John Lonski in Monday’s USAToday.