Why Is the Dollar Losing Value?

The Canadian dollar has reached parity with the U.S. dollar for the first time since 1976. They are now equal in value. The euro also soared to its highest-ever level against the dollar, trading above $1.40 for the first time since the currency was introduced in 1999.

So why is the dollar plunging, and what impact does that plunge have on U.S. and world markets? Here's a look at some of the reasons for the dollar's fall, and the consequences

Why the Weak Dollar?

There are several reasons. First, there's the difference between the interest rate in the United States -- the one the Federal Reserve just dropped by half a percentage point to 4.75 percent -- and the interest rates of other central banks around the world.

When the United States dropped its rate, other banks did not follow. Now the spread between the interest rate at the European Central Bank (home of the euro) and the Federal Reserve (home of the dollar) is smaller than it has traditionally been, and that has weakened the value of the dollar against the euro. Put another way, you would get a better interest rate return holding a euro than a dollar.

Second, central banks around the world have been diversifying their holdings away from dollars to euros, British pounds and so on. That means there are more dollars out there in currency markets available to purchase. More dollars floating around means diminished value.

What Effect Does This Have?

Look at the record-high price of oil. Even if the same amount of oil is being pumped out of the ground, since it is traded in dollars and the dollar has weakened, the price of oil has increased to make up for the lost value of the dollar, creating a sort of vicious cycle.

Oil-producing countries don't want to keep all the dollars they are getting for their oil, since it's worth less, so they are diversifying and converting their dollars into euros or other currencies. That pushes more dollars back out into currency markets, which in turn pushes down the dollar's value.

One analyst told ABC News that Russia used to have 90 percent of its financial reserves in dollars. It now has 45 percent in dollars, 45 percent in euros and 10 percent in British pounds.

What Does This Mean in the U.S.?

The news is mixed. It's good, because it makes what we produce here cheaper to sell in foreign markets, and that in turn spurs exports of our products around the world. That translates into more manufacturing and more jobs. For example, BMW and Mercedes Benz want to build cars in the United States, because they can do it cheaper in nonunion states than in Germany, where they'd pay labor and parts in euros, and then bring the cars to the United States, where they would be too expensive to sell at a profit.

But a weak dollar is bad, because it leads to inflation in this country. Imports from foreign countries will become more expensive, and in particular, oil will be more expensive. That puts pressure on businesses to increase prices for anything that uses oil or products that come from overseas. One benefit for American shoppers is that China has largely pegged its currency to ours, so that keeps the price of Chinese-made goods low and therefore, keeps a check on inflation.

Page
  • 1
  • |
  • 2
Join the Discussion
blog comments powered by Disqus
 
You Might Also Like...