Thursday, October 30, 2008

Is A Strong Dollar Good For US Economy?

One of the curious features of the last couple of months is the unexpected strength of the US Dollar against a basket of currencies. This includes the currencies of emerging economies, but the dollar has also been strong against currencies such as the Euro, Pound Sterling, Canadian Dollar and the Australian Dollar. The reasons for the dollar's rise are briefly
  • Lack of confidence in other countries.
  • Economic slowdown has spread from US to Eurozone area - leading to lower European interest rates.
  • Financial crisis has spread to other emerging economies. Investors are even more nervous about these economies than the US financial system.
  • There has been a strong demand for dollar as hedge funds have been withdrawing their capital from oversees market, and putting it into the relative 'security' of the dollar.
With US interest rates cut to 1% yesterday, the strength of the dollar is likely to prove temporary. Indeed many commentators suggest with an increase in the US Money supply, to finance a growing national debt, the dollar looks like a bubble ready to burst.

Nevertheless this is the Impact of A Strong Dollar on Global Economy
  • US exports become more expensive. With a global slowdown, US exporters are likely to experience very difficult conditions pushing economy further into recession.
  • Makes Imports cheaper. Imports to America play an important role in the global economy. A stronger dollar increases the purchasing power of American consumers and leads to higher exports. However, cheaper imports may not be sufficient to boost spending. With confidence at an all time low, American consumers are more likely to try and boost their saving rates, rather than buy more imports.
  • Strong Dollar will worsen the US Current Account. At around 5%, this will mean the US will need to attract more capital inflows to finance its trade deficit. However, with US interest rates at 1%, and the credit worthiness of the US being openly questioned, it is going to be difficult for the US to attract any more capital flows. This is another reason why the dollar's strength appears rather illusory.
  • Good for Global exporters to US. UK firms who export to US may benefit from strong dollar, but, the exchange rate benefits may be outweighed by the global downturn.
Normally, a strong exchange rate reflects a strong economy. If the economy is in good shape - high growth, low current account deficit, low borrowing, an economy can deal with a strong exchange rate and prosper.

However, given the perilous nature of the US economic situation, the strong dollar doesn't really help them at all. The Strong dollar reflects a misplaced hope that the dollar offers security in the credit crunch. But, with the fundamental problems in US, the strong dollar will only worsen the US Economic downturn.

No comments: