Personal Finance Advice

A slumping dollar has helped spur U.S. exports as well as foreign investment and has contributed to a decline in the Current Account, a measure of international trade. However analysts cautions that this trend may not continue.

“Capital inflows into the U.S. surged in October, but cyclical downside and persistent credit concerns suggest the October print was a flash in the pan and not the start of a new trend,” said Gabriel de Kock, currency economist at Citigroup Global Markets in New York.

“The U.S. external deficit remains large and longer-term trends in capital flows suggest that foreign private investors are becoming less willing to fund the U.S. deficit,” he added.

Foreign investment won’t be helped by the Bush Administration’s mortgage bailout plan which freezes adjustable rates for five years. Anytime you have the government interfering in private contracts, investors will become wary, both foreign and domestic.

While the overall trade deficit has been narrowing in recent months, our trade gap with China continues to widen to record levels. The possibility of a trade war can’t be discounted.

There has been a large outcry of public sentiment for the imposition of trade sanctions. The recent scandal involving contaminated toys manufactured in that country hasn’t helped matters either.

As a large holder of our national debt, China has expressed in recent months, a reluctance to carry such large amounts a dollar denominated assets. A thinly veiled threat of their ability to wreak further havoc on our already beleaguered financial system.

Since the abandonment of the Bretton Woods System of fixed exchange rates in the 1970’s, the dollar has had it’s fair share of ups and downs.  Currently the dollar is on a sharp downward trend, losing about 30% of it’s value over the past few years.

Factors currently contributing to the weak dollar

There are a number of factors that can contribute to a weak dollar and some of them are interrelated.  The ones that are currently to blame are as follows:

• Lower relative interest rates compared to other countries
• Large annual trade deficits
• Higher relative inflation rates compared to other countries
• A weak domestic financial market

It is important to note that the value of dollar would be even worse were it not for the large annual government budget deficits which attracts foreign investment that finances our national debt.

Winners and Losers

Some are helped by the weak dollar:

• U.S. firms have stronger exports with cheaper relative goods which are priced in dollars.
• Foreigners find it cheaper to vacation in our country.
• Foreigners find it cheaper to invest in our markets.

And of course some are hurt by it:

• Consumers have to pay more for imports, which in turn contributes to inflation.
• Americans find it more expensive to vacation in foreign countries.
• U.S. individuals and businesses find it more expensive to invest in foreign markets.

Another important note is that while our exports have improved somewhat, we still have a trade deficit.  While the trade gap with China has been making headlines recently, it is our dependence on foreign oil which is the main culprit.  Our demand for oil is relatively inelastic to the price, meaning no matter how high the price rises, demand will only fall slightly as there is certain amount that we must have in order to maintain our industries and our current lifestyles.

What is troubling is the news that OPEC has had recent discussions of de-pegging the price of oil to the dollar and instead use a market basket of currencies.  This will mean even higher prices for oil in the future and larger trade deficits which will in turn further weaken the dollar.