Why is the dollar falling against the Euro?
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Just Askin
Answer:
There is an expectation that Europe will raise interest rates.
The trade deficit.
The trade deficit with Europe was $117B last year. Since 2000, the total is over $500B, close to 5% of the economy. Hence, when U.S. consumers buy $500 billion more from Europeans than they buy from us, it puts a huge amount of extra dollars in the hands of Europeans. While most of those dollars find their way back to the United States (capital flows back to dollar denominated assets), not enough has come back. Thus, like any commodity, when there is excess supply, the price falls.
While we've had trade deficits for sometime, the attractiveness of U.S. assets is not quite the same post 9/11 as during the 1990s when the U.S. stock market was booming and interest rates were much higher than today (remember savers want higher returns, not low interest rates). In spite of the problems in Europe, we are not getting sufficient return of those dollars to offset the trade deficit.
Because the perceived value of the dollar is going down. The US economy is struggling (notwithstanding the stock market's performance), jobs are being outsourced, the trade deficit is getting bigger by the minute, the war in IRAQ is draining the coffers of the treasury, the dependence in oil is causing a slowdown in private sector committment to investing in new factories, the political atmosphere is divisive instead of cohesive. The dollar is everywhere. The June 4, 2007 issue of time (page 53) states that China this year will have a surplus of $300 B on top of the $1 Trillion it has already accumulated from trade with the US. Not to mention the Trade surplus that Japan, Saudi Arabia, and other countries mostly oil exporters enjoys against us. In 2006,US investment surpluses of the previous years (the difference between investment income of US companies abroad and investment income of companies doing business in the US) suffered a $7.3 Billion deficit. If a rich person who you know is debt ridden comes to you and asks for a loan promising to pay you in two weeks, will you lend him the money? Or will you lend your money to your next door neighbor who although he only earns a middle class income is known to you as a frugal person who is debt free and always pays his obligations on time? Remember that the US $ in a way is a promissory note that in exchange for the piece of paper it is written on, promises to give you value in terms of the goods and services that you can redeem with it. The EURO therefore is more attractive since it carries the aura of being able to hold more of it's value compared to the US $ .
Dollar is falling against the Euro because in the international market a view is gaining strong ground that the US economy will not be able to bring down its current account deficit for quite sometime and US exports will not be able to rise in value enough to pay for the imorts the US is makng. There seems to be continued perception that the US economy will soon get into recession which it has avoided for long. There is also a feeling that the US is sqanduring large resources in military operations outside the US which are unproductive and the US economy is unable to grow in the manufacturing sector. There is low savings and investment by the US households and corporates and the Govt. This means future growth will be adversely affected. While all these perceptions may not turn out to be correct, these perceptions are leading foreign investors to reallocate their holding of inetrnational fianncial assets from investments in US treasurets and others to assets issued in Euro. Until that reallocation of portfolio, there is lower demand for dollars thn the supply of dollars in the ineternational market relative to Euro.Euro being a currency which is more broadbased and diversified is felt to be more stable. Thus the apprehension that the value of dollar will continue to fall is leading to greater demand for Euro in exchange for dollars which therefore is putting further pressure on dollar to fall, some kinfd of self-fulfilling prophecy. But this is in a sense good for the US economy. It makes it cheaper for foreigners to buy US goods and hence help exporters from US if they are really interested in export of goods that the third world needs. But the decline in the value of the dollar is making import of petroleum oil costlier to both US and other countries who are dependent on exports to US. This may imply rise in inflation for US consumers so heavily dependent on oil for transportation and various petrochemicals. This further affects the outlook for the dollar's value. The current trends are an aberation but principally fuelled by the basic imbalance that the US consumers are ready ( correctly so) to import all sorts of consumer goods available so cheap from China and other poor countries while the consumers and corporations are not yet ready to buy in substantially large quantities the goods produced cheaply in the US like AIRcrafts, weapons, very high technology. The reason is the poor countries do not need that much of high technoly and aircraft transportation in the course of their ordinary life till their citizens become rich enough and upgrade their life style and level of living. Moreover, nowdays the poorer countries are able to upgrade technologically at a faster pace by copying and reverse engineering. So, the US needs to lift its pace of technological progress and work on high technology products that can be consumed by poor countries.
Another factor which is contributing to continuous dollar depreciation is the current strong boom in the prices of commodities in general. In commodities the US dominance is far less now than the poorer countries. As the commodity cycle transits to its next decline phase, the pressure on dollar may ease somewhat.
However, all this is normal in international markets and one need not worry about the depreciation in the value of dollar at the current times. Economics has its own way of correcting things / trends: nothing, especially imbalnces, can continue for long.
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