The Weakening Dollar: causes and impacts

After a record hike in value at the end of 2019, the US dollar is expected to hit the lowest exchange rate against the euro in the last decade in a year. The downward slide started around the end of March and has been sliding ever since.  

Several strategists expect the dollar to stay down for quite a long time before a good enough recovery. This is evident in the currency trade market where offshore investors are shorting the dollar.

What caused this sudden depreciation of the US dollar?

  1. The hike in the value of the dollar at the beginning of the year was due to the heavy rush towards the US treasury reserves to stay safe in the face of the impending recession. However, the dollar failed to stay afloat in the aftermath of the pandemic, and several buyers switched to other currencies.

  2. Inefficient management during the COVID-19 pandemic resulted in the US lagging in reviving the economy while other countries picked up the pace by managing to control the pandemic more effectively. [*]Strengthening of other currencies, noticeably euro and yen on the dollar index entail that dollar falls short in the foreign exchange market. This encouraged investors to leave dollar reserves and opt for other currencies in their reserves, which doubled the impact on the US dollar.[*]The Federal Reserve announced that they would delay hiking interest rates and temporarily tolerate inflation rates higher than the 2% threshold to help boost economic activities and let the smaller businesses catch up before focusing on raising the value of the US dollar.

What does this mean for the US economy?

  1. Low exchange rates mean that the dollar is weaker in comparison to some other currencies, prominently, the euro. This can be good news for the US export businesses since they will be able to attract more buyers in the foreign market at prices on par with their competitors.

  2. Cheaper export rates can attract more investors in US stocks with the hope that they can buy cheap now and sell for higher rates when the dollar picks up eventually. An influx of foreign investors could, in turn, have a positive effect on the US economy. [*]Stock markets can benefit from weak dollar values due to higher foreign investments in American businesses since American companies will now be cheaper to acquire.[*]However, if the dollar continues to be down for a long time, imported goods will become more expensive, triggering a bad hit of inflation down the road.[*]Home loans and real estate will be more expensive since a decline in the value of the dollar directly affects the value of US treasury bonds that will result in a hike in interest and mortgage rates. When the dollar declines in value, the demand for US treasury reserves declines, forcing the banks to increase the security on the bonds that are offered during the decline, which manifests as higher interest rates. Higher interest rates owed by the banks impact the interest rates on mortgages offered by the banks.

How does a weaker dollar affect the global economy?

  1. When the dollar weakens, it means the relative value of the dollar is lowered in the foreign exchange market. This would automatically imply that the euro and yen strengthen in comparison.

  2. Foreign commodities such as oil and gold are priced in dollar denominations. A decline in the value of the dollar will lead to a hike in oil prices since the foreign traders will have to maintain their profit margin in view of the low dollar: foreign currency trading exchange rates.[*]Foreign investors who currently hold US stocks will sell, implying lesser confidence in the US economy. However, if the long term forecast sounds good for the dollar, depending on factors such as the debt currently owed by the US government, investors might choose to hold on to their stocks and till the economy stabilises.[*]An extreme yet reasonable prediction is that the current depreciation might result in the dollar losing demand as the reserve currency of the world. China is already at work to make the yuan the reserve currency, and the consistent appreciation of euro in the past year indicate that it might draw in a lot of buyers.[*]An expected positive aspect of a weak dollar is that emerging businesses in developing countries that borrowed money in dollar denominations can afford to pay off the loans during a decline in the value of US dollars. However, experts observe that in the face of a pandemic and the resultant halt in industry growth, the weak dollar might not be as advantageous as expected for the developing countries./\r\n/The current scenario does look bad for the US dollar. However, it is important to keep in mind that these fluctuations are essentially cyclical for any currency. It is a matter of time before the trend reverses. Long term displacement of the US dollar as the global currency is not a reasonable prediction when it comes to currency trading.

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