Wednesday, August 20, 2008

Is a Stronger Dollar A Good Thing?

I have just arrived in New York for a holiday (my posting schedule may tail off until September), Unfortunately, the recent strength of the dollar in the past few weeks, increased the cost of my holiday by about 10%. If I had travelled earlier in the year I could have got closer to $2 for a £1, rather than the $1.8 to a £1 I got yesterday.

Euro Dollar Exchange Rate

After reaching a low of 0.62 Euros per dollar, the dollar has regained some of its lost ground - now trading at 0.67 Euros. But, as this graph shows the recent 'strength' of the dollar is insignificant compared to its long term fall.

However, even this small reversal will come as welcome news to Americans who love to travel and buy from abroad.

For the US economy the strong dollar is something of a mixed blessing.

Exports The weak dollar has been boosting growth in the US, at a time when other sectors have been struggling. Without exports increasing by 8% a year, the US economy may already be in recession; as it is the US economy continues to struggle along.
  • However, on the other hand, you could argue that relying on a very weak dollar to underpin the economy, provides only a mere temporary respite and masks the underlying problems of the US economy.
Inflation. Despite the economic slowdown, inflation continues to pose a threat. A stronger dollar helps reduce inflationary pressure because:
  • Imports cheaper.
  • Lower demand for exports and hence domestic Aggregate Demand
  • Exporters forced to try and increase efficiency.
If the dollar had remained very weak and inflation continued to rise, there would have been pressure on the Federal Reserve to increase interest rates; something they wouldn't like to do in the current situation, even if real interest rates are negative.

Current Account deficit. The current account deficit seems of small concern these days, with the housing and financial crisis. The recent weakness of the dollar has slightly improved the deficit from 6.5% of GDP in 2006 to about 5% of GDP now.

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