Tracking the US Dollar

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The dollar goes up, the dollar goes down. Recently, it has been down. From January 2, 2002, to March 7, 2003, the dollar fell 20 percent against the euro, 10 percent against the British pound, and 13 percent against the Japanese yen. Historically, such fluctuations are not unusual, though they are seldom easy to explain.

Ask an economist to describe the reasons for the greenback's recent decline, and the reply will include a furrowed brow. Few subjects are as complicated or confounding to us as the foreign-currency exchange rate market - the deepest, most liquid, and one of the least regulated markets in the world.

Each day, more than $1 trillion in currency trades in the foreign-exchange market. Many participants and factors affect the value of one currency versus another. The market consists of a worldwide cast of businesses, investors, speculators, governments, and central banks, acting and reacting on the basis of a mix of forces such as trade patterns, interest rate differentials, capital flows, and international relations.

As the dollar has recently undergone its worst slide against European currencies since 1987, the overarching reason can be attributed to a reduced demand to place investment funds in the USA, a situation quite different from that of the late 1990s. Between 1995 and 2000, the attractiveness of US capital markets resulted in the dollar rising 20 percent against other major currencies. Recently, with the decline in the US stock market as well as lower interest rates on US government securities, outside investors have turned skittish. Other confidence crushers include the corporate accounting scandal of 2002 and rising tensions with Iraq and North Korea.

A weakened dollar, despite the negative connotation, does carry certain benefits. Although American travelers and businesses are not able to stretch their money as far on foreign soil, the opposite is also true: foreign consumers are able to purchase more US goods with their beefed-up currency. Such behavior, in theory, could help reduce the US trade deficit, which swelled to a record $44.2 billion in December 2002.

If the dollar's recent decline can be attributed to the slowdown in the US economy, along with corporate governance and geopolitical uncertainties, then recent weakness in the dollar is not a matter for serious concern. As the economy rebounds, we would expect foreign investment to make a comeback, and the dollar with it. So, remember: the dollar goes up, the dollar goes down. These are normal fluctuations in a well-functioning and vigorously competitive market.

Source. William Poole, "Tracking the US Dollar," A Quarterly Review of Business and Economic Conditions, Apr. 2003, p. 3.

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