From February through July 2002, the value of the U.S. dollar decreased 9.4% against major currencies. However, by August it had climbed 1.8%, likely indicating a temporary pause in its downward trend.

The overall decline is welcomed by U.S. exporters, whose products have become less expensive and more competitive abroad. But where will the dollar go from here? Is its level of volatility a concern? And how will it impact your business?

A Historical Perspective

Since March 1973, when the Federal Reserve’s Nominal Major Currencies Dollar Index was set at 100, the value of the U.S. dollar reached its highest level in March 1985, at 140.35. Its lowest point came about 10 years later in April 1995, when it fell to 77.68.

Last February, the index reached 108.82, its highest value since April 1986, compared to major currencies. However, it dropped to 98.57 by July, but then increased slightly in August to 100.31, according to the U.S. Federal Reserve. Although the dollar’s value has dropped considerably, it is still well above its mid-1990s level.

What’s Driving the Dollar’s Value?

During the 1990s, foreign investment flowed into the United States at an unprecedented pace. The longest U.S. peacetime expansion on record, strong productivity gains and a stock market with exceptional returns attracted capital from all corners of the globe. Additionally, after the Asian crisis and uncertainty over the value of the euro, investment looking for a safe haven poured into the U.S. These factors largely contributed to the rise in the dollar’s value.

But for quite some time, economists predicted the U.S. dollar was due for a correction. The U.S. current account deficit (which is the largest of any nation), less investment from abroad, a volatile American stock market, and a decline in U.S. confidence have contributed to the dollar’s overall decline. And these and other factors likely will continue to put downward pressure on the dollar. How low and how fast it will fall is impossible to predict.

The Impact of the Highs and Lows

The change in value of any currency has a substantial impact on trade and investment trends. For example, because the value of the U.S. dollar rose 40% from April 1995 through February 2002, the cost of a
$1 million American machine was increased by $400,000. Not surprisingly, this resulted in lost export deals.

To compensate for the stronger dollar, many U.S. producers attempted to increase productivity in order to remain internationally competitive. Many were successful, and U.S. productivity outpaced most other countries. However, those manufacturers who did not increase productivity or resort to lowering prices watched their products lose marketshare abroad, as well as in the United States due to rising imports.

On the other hand, the rise in the dollar enabled U.S. companies purchasing foreign assets to obtain more for their money. But, U.S. firms already invested in foreign production facilities generated smaller profits when converting their foreign currency revenues into dollars.

A weak or declining dollar has the opposite effect. As the value of the dollar decreases from its recent high in February 2002, the cost of U.S. exports, in terms of the importers’ currency, are becoming more attractive, allowing foreign importers to obtain more for their money. The result: U.S. exports as a whole are likely to rise.

A Billion Yen Doesn’t Buy What It Used To

In 1995, one U.S. dollar could buy 93.96 yen, according the Federal Reserve. However, by May 2002, one dollar was worth 126.38 yen, reflecting an increase in the dollar’s value or a decrease in the yen’s value, depending on your perspective. By July 2002, one dollar was, on average, equal to 117.90 yen, reversing the previous trend.

To a large degree, Japan depends on exports to generate economic growth. A weakening yen means more Japanese exports, but a strengthening yen makes Japanese products more expensive and less attractive abroad. And, as the yen increases in value compared to the dollar, Japan’s Asian competitors gain an export price advantage. As a result, the strengthening yen has been a major concern for Japanese policy planners. To compensate for the declining dollar, on several occasions the Japanese government has intervened in world currency markets in an attempt to prop the dollar up and to push the yen down.

The Euro Reaches Parity with the Dollar

Over the past several years, investors repeatedly expected the single European currency, the euro, to gain against the dollar. But, the euro entered each new year with high expectations that never materialized.

However, following a smooth transition to euro notes and coins at the beginning of 2002, markets reacted positively. Months later, some analysts predicted the euro eventually would challenge the dollar for world dominance. On July 16, 2002, and continuing through July 23, the euro average daily rate hit the $1 mark for the first time in several years.

The Next Step

Currency volatility can be very damaging, as demonstrated by the Asian crisis that began in 1997. With the front page news of plunging currencies — beginning with the Thai baht and quickly affecting the Malaysian ringgit, the Indonesian rupiah, and the Korean won — it is easy now to understand the risks generated by currency fluctuations. Not only did the domino effect put pressure on traditionally strong currencies, but it also resulted in banking and financial crises, as well as economic recessions in several countries.

Exporters, importers and investors need to be aware of the impact currency shifts can have on their business, and work closely with their banker to eliminate the risks.

This article appeared in July 2002. (CB)

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.

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