The idle ramblings of a Jack of some trades, Master of none

Sep 24, 2007

Falling Dollar

While we are on the subject of currencies, the US dollar is now at an all-time low against a basket of currencies. When I say all-time, of course I mean since Bretton-Woods was dissolved.

For the Canadians, long the poor country cousins of the Americans, this is superb news. The Loonie is stronger than the buck for the first time in yonks. Droves of Canucks are braving long immigration queues at border crossings to shop till they drop in the USA. Frontier towns on the Canadian side of the border find that their shops are struggling, tourism is affected and there are worries about funding the next Winter Olympics, while American dealers in cars, electronics, food are thrilled to bits.

How long will this last? There's talk of a decoupling between the CAD and the USD. Till May this year, the Loonie acted as a turbo-charged dollar: essentially correlated with the latter, but moving up or down faster than it. Since then, the Canadian economy, driven mainly by rising commodity prices, has lessened its dependence on the US. While the US struggles with a credit crunch, dropping real-estate prices (and therefore net-worths of its citizens), and its various deficits continue to remain enormous, the market expects that the Loonie (and other commodity currencies like the Australian dollar) will continue to appreciate.

To counter this argument is the fact that US imports are dropping. Some economists argue that this would act as a natural floor for the USD as demand for foreign currencies drops because of the smaller need among American consumers to go out and buy.

The Saudis have intrinsically loosened their peg against the dollar by not responding to the recent Fed cut in the funds rate. They are worried by their domestic inflationary pressures caused by the rising cost of imports while their earnings from oil remain flat, despite the increase in oil prices. The dollar is the reserve currency for the planet, which means, in essence that the Americans can print as much of it as they want to buy anything they want. Especially oil. They know that the world will soak up their currency excesses. But if the dollar's value keeps dropping, people will find that their reserve holdings lose purchasing power, which might drive them to diversify into other currencies: they will sell the dollar, buy the other currencies, leading to a further depreciation in the reserve currency.

Are we seeing the end of the dollar as the world's favourite money? Your guess is as good as mine.


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