Wednesday, November 17, 2010

Impact of Fall in Value of Dollar

The US dollar has fallen in recent months because markets are worried about the policy of Quantitative Easing - increasing supply of money supply and dollars. This raises prospect of higher inflation in the US and makes the US dollar less attractive.
What is the global impact of a fall in the value of the dollar?

Impact on US
  • US exports become more competitive helping to boost US exports
  • Imports into the US become relatively more expensive leading to lower demand for imports. This will adversely affect countries who rely on exporting goods to US.
  • The weaker US dollar will lead to increased inflation. Usually this is seen as a bad thing. However, the Fed and many economists are concerned about inflation in the US being too low. They fear the US inflation is falling below its target of 2%
  • The weaker dollar seems to offer benefits to the US economy - higher growth, higher employment and a higher inflation rate to reduce prospects of deflation. This monetary / exchange rate policy is especially important given lack of room for manoeuvre over fiscal policy.
Impact on Bond Market

A weaker dollar makes it less attractive for foreign investors to hold US bonds. This could lead to private investors selling US bonds and moving into other countries and other investments. In the short term, these will be offset by the Fed buying back US Treasuries.

Impact on Developing Countries
  • Developing Countries will find it more difficult to export to US. This may lead to job losses as exporting firms may go out of business.
  • However, the large trade surplus in countries like China suggests the economy is unbalanced and too reliant on export sector. A weaker dollar may force the economy to rebalance and focus more on domestic demand rather than relying on US demand.
Impact on Commodities

The fear is that if dollar assets become less attractive because of the dollar devaluation, then there will be a move into other assets like commodities such as gold. This could lead to an unsustainable boom in the price of commodities, which later creates problems.

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