FAQ: How does the value of the dollar impact the U.S. economy?

Talking Points:

The effects of a rising or declining dollar are complex and not always well understood. When the dollar decreases in value, U.S. exports typically become more attractive abroad. In turn, companies selling more goods and services often hire more workers. But a decreasing dollar has other consequences. For example, U.S. manufacturers who rely on imported components and materials find it more costly to produce their goods. In turn, these manufacturers may absorb this added cost, which will reduce corporate profits and possibly impact hiring. Or, they may pass this increase on to consumers, which could lead to inflation. Additionally, a dollar that is weakening or declining in value for lengthy periods of time or at a rapid pace can dampen investor confidence and result in less U.S. inbound investment. In turn, this can make it difficult to finance budget deficits and may lead to higher interest rates. Thus, business expansion becomes more costly and compromises the ability of companies to hire new employees.

A rising dollar, which often leads to increased foreign investment in the United States, makes U.S. exports of goods and services more expensive abroad and can result in lost export deals. Additionally, according to Fred Bergsten of the Institute for International Economics, every 1 percent rise in the U.S. dollar’s trade-weighted value boosts the U.S. current account deficit by at least $10 billion. If perceived as unsustainable, a rising current account deficit can negatively affect confidence in the U.S. economy, and in turn, accelerate downward pressure on the dollar.

Overall, a rising or declining dollar has a number of positive and negative consequences. But one thing is certain: a stable and predictable dollar is extremely important to the well being of the United States. (For information on the Chinese currency, see Part I).

FAQ: How has the value of the dollar fluctuated since the 1970s?

Talking Points:

In March 1973, the Federal Reserve’s Nominal Major Currencies Dollar Index was set at 100. In March 1985, the U.S. dollar reached its highest level at 143.90. About 10 years later, in April 1995, it fell to 80.33. Within seven years it climbed up to its recent peak of 111.98 in February 2002, as compared to major currencies.

Why did the dollar rise through February 2002? 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.

Why did the dollar lose value after February 2002? By early 2002, the U.S. current account deficit, the budget deficit, less foreign investment in the U.S., a volatile American stock market and a decline in U.S. consumer confidence all contributed to the dollar’s subsequent decline. As a result, the dollar fell to an all time low of 80.11 in December 2004. As of July 2005, the dollar stood at 85.77.

FAQ: Has the weaker dollar slowed U.S. imports?

Talking Points:

As the dollar decreased, many assumed that U.S. imports would slow since it would require more U.S. dollars to buy foreign goods. But as of June 2, 2005, this has not materialized. According to Catherine Mann of the Institute for International Economics, “With the exception of oil, imports have not become more expensive. One reason is that about 30 percent of our imports come from countries whose currencies have either moved little (the Thai baht), stayed stable (the Chinese yuan), or fallen (the Mexican peso) against the dollar.

But another reason is the worldwide decline during the 1990s of what some economists call ‘pass-through rates,’ that is, the extent to which changes in the exchange rate induce changes in a country’s import and export prices. A study by economists Linda Goldberg and Jose Manuel Campa found that pass-through rates for the United States were significantly less than for other industrial countries. A 10 percent change in the dollar has generally yielded only a 2.5 percent change in American import prices within one quarter, and only a 4 percent price change after several quarters. Another study by the Federal Reserve found that the pass-through was nearly zero.” Mann notes several factors explain a low pass-through rate, including low global inflation and the fact that foreign exporters are willing to take smaller margins in order to retain U.S. marketshare. As a result, Mann says it will take a bigger drop in the dollar to change import prices enough to slow the American appetite for foreign goods.

FAQ: What is the impact of the euro?

Talking Points:

Unlike the original 15 EU members—Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden and the United Kingdom—the 10 new EU accession nations must adopt the euro when they fulfill specific requirements. This may take several years. But given their limited circulation and high levels of currency volatility, joining the euro area, also known as Euroland or the Eurozone, is an advantage in terms of stability and confidence.

Three of the original 15 EU members have a very different set of concerns and issues regarding the Eurozone. In past nationwide referendums, both Denmark and Sweden voted against euro participation. And according to analysts, the United Kingdom is unlikely to adopt it any time soon. Nationalists from these countries argue that euro participation will erode national sovereignty and hand over power to the European Central Bank whose “one size fits all” policies may not be welcomed. Furthermore, many are concerned that the single currency could lead to a political union that may promote legislation they do not support. The UK, which has been especially critical of the euro, has established five economic tests it says must be met before it calls a referendum. Prime Minister Tony Blair supports adopting the euro. But the Tories, the opposing conservative party, are against this in the immediate future. Britain’s attachment to its relatively stable pound sterling, which has an unbroken history of more than 900 years and has dominated global trade for decades, is proving difficult to break.

The Eurozone, which currently represents a population of 305 million people, has benefited from the single European currency in a number of ways. According to an EU study, the establishment of the euro eliminated transaction costs estimated at 0.5 percent of GDP. Other studies estimated this cost closer to 1 percent. An International Monetary Fund study projects the euro will increase GDP growth in participating member economies each year, and by almost 3 percent in 2010. Plus, greater macroeconomic stability and reduced governmental deficits are anticipated in an economically stronger Euroland. These and other benefits generated by the euro are attractive to newcomers.

It is estimated that approximately 60 percent of world trade is denominated in U.S. dollars. This may change. As new EU members adopt the euro, they will request their U.S. partners to transact business in the currency. And, as the EU and Euroland expand (Bulgaria and Romania may join the EU by 2007), complying with this request likely will give U.S. companies a competitive advantage over companies that don’t.

FAQ: How did the Mexican peso crisis affect the United States?

Talking Points:

Currency instability in developing countries negatively impacts U.S. exporters and investors, and harms our economy’s ability to create jobs. For example, on December 20, 1994, on the verge of entering the second year of NAFTA, the economic situation drastically changed. An attempted currency adjustment by the Mexican government accelerated out of control. The Mexican government expanded its exchange rate band by 15 percent in an attempt to allow the peso to adjust downward. Within two days pressures mounted and currency reserves used to prop up the peso quickly dwindled. As a result, the peso was allowed to float freely. Shortly thereafter, it nose-dived.

From December 20, 1994 to March 1995, the peso dropped about 40 percent in value as compared to the U.S. dollar. Like falling dominoes, what began as a short-term liquidity crisis, turned into a full panic. The Mexican stock market dropped precipitously. Most investors whose money came due did not reinvest in the country. As the value of the peso declined, the Mexican government was forced to raise short term interest rates by a dramatic amount to prevent a massive outflow of capital invested in Mexico and to fight inflation. At the time, a significant percentage of Mexican debt was in the form of tesobonos, securities denominated in dollars but paid in pesos. Tesobonos were designed to attract foreign capital by shielding foreign investors from exchange rate risk. Approximately $774 million worth of tesobonos matured on December 28, 1994; another $5.2 billion came due mid-February 1995. A total of approximately $28 billion in dollar denominated debt came due in the first half of 1995—an amount which had to be paid out in order to maintain some semblance of stability.

This situation, coupled with the assassination of Luis Donaldo Colosio, the Institutional Revolutionary Party (PRI) presidential candidate and former Secretary for Urban Development and Ecology, raised questions among foreign investors as to Mexico’s political stability. The assassination of Francisco Ruiz Massleu, a senior ranking PRI official, added to this uncertainty. These events, combined with unrest in the southern state of Chiapas, further fueled investor skepticism. Mexican fallout quickly spread to Brazil and Argentina, whose stock markets fell, along with those in other developing countries worldwide. Investors received what some have referred to as a “wake-up call,” reminding them that political and economic instability can largely affect growth prospects in developing countries. In turn, U.S. exporters and investors must remember they too can be subject to considerable economic difficulties.

FAQ: How did the Asian financial crisis impact the United States?

Talking Points:

During the 1990s, Southeast Asian countries increasingly pegged their currencies to the U.S. dollar. After mid-1995, the U.S. dollar began to appreciate. As this occurred, Southeast Asian exports became more expensive while pressure mounted on their national exchange rates. In late 1996, foreign investors questioned Thailand’s ability to repay its loans and began to move their money out of the country. Fearing a loss in the Thai baht’s value, foreign investors and Thai companies began in February 1997 to convert the currency into U.S. dollars—accelerating a devaluation. With diminished reserves, the Thai central bank was forced to let the baht float downward.

Fearing neighboring countries shared many of the same weaknesses as Thailand, confidence in Malaysia, Indonesia and South Korea plummeted, resulting in a regional financial crisis. Consequently, economic growth in emerging Asian countries, excluding China, dropped precipitously.

Regions of the U.S. that were more dependent on exports to East Asia were affected to a greater extent than less dependent regions. Western states, such as Washington, Oregon, Arizona, California and Alaska, were more affected due to their higher concentration of exports to East Asia which included aircraft, semiconductors, electrical equipment and processed foods. Parts of the farm belt, the industrial Midwest and southern states were affected to a lesser degree. The Northeast, including New York, New Jersey, Pennsylvania and Connecticut, probably were impacted the least since a smaller percentage of their exports targeted the affected region. Additionally, many U.S. companies that were invested in the most affected Asian countries experienced severe difficulties.

This section appeared in Part III: Frequently Asked Questions and Talking Points of the book Grasping Globalization: Its Impact and Your Corporate Response, 2005.
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John Manzella
About The Author John Manzella [Full Bio]
John Manzella is a world-recognized author and speaker on global business, competitive strategies and the latest economic trends. He also is CEO of World Trade Center BN, chair of the Upstate New York District Export Council, and founder of The Manzella Report and Manzella Trade Communications Inc. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.




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