From 2002 through late 2007, the U.S. dollar declined 39 percent against the Canadian dollar, 38 percent against the euro, and 30 percent against the British pound, according to Deloitte Research. Interestingly, the impact is different than it would have been years earlier.

Dollar Will Continue To Dominate

The dollar is “losing its status as the world currency,” said Xu Jian, a Chinese central bank official, last November. “We will favor stronger currencies over weak ones, and will readjust accordingly.” Although this statement was later qualified, concerns exist that central banks around the world will diversify their foreign exchange reserves out of dollars and into other currencies—a move that would push the dollar even lower.

French President Nicolas Sarkozy told Congress “If we are not careful, monetary disarray could morph into economic war.” And the major economic powers isued a warning at the April G-7 meeting that they won’t sit by and watch the dollar continue to slide.

As it comes under increasing attack, will the dollar continue to be the world’s major currency?

Although slightly lower, the dollar still is involved in 86 percent of the world’s 3.2 trillion daily currency transactions and comprises 64 percent of total global reserves, The Wall Street Journal says. As a result, it continues to be the world’s dominant currency and is unlikely to lose this position any time soon.

Impact of Fluctuations Are Complex

In March 1973, the Federal Reserve’s Nominal Major Currencies Dollar Index was set at 100. Since then, it reached a high of 143.91 in March 1985 and fell to an all-time low of 70.32 in March 2008. In April, it rose slightly to 70.58.

Trying to predict the dollar’s long-term trend and impact is extremely difficult—and more so than ever due to new global factors at play.

Why? A weakening dollar traditionally resulted in lower priced American exports that stimulated sales abroad. It also caused the price of foreign goods and services to rise, reducing U.S. demand and effectively lowering the trade deficit. These past realities, although still applicable, no longer play out as they did years ago.

Today, U.S. producers increasingly rely on imported raw materials, capital machinery and parts, industrial supplies and other intermediate inputs used in the manufacturing process of their products. When the value of the dollar weakens, these imports become more expensive. When these same producers’ finished products are exported, the advantages of a weak dollar can be neutralized by the higher cost of inputs.

According to The Wall Street Journal, “Supply disruptions in various places and surging demand in China and India are part of the explanation for this decade’s upward trend in oil prices. But perhaps the biggest factor has been largely overlooked: the decline in the value of the dollar.” The Wall Street Journal says the cost of an imported barrel of oil would be closer to $57 instead of $100 if the dollar had kept pace with the euro this decade. Consequently, higher costs incurred by U.S. manufacturers for energy and other imported inputs have impacted U.S. export prices, as well as the U.S. trade deficit.

Nevertheless, due to productivity improvements, creative cost reductions and the declining dollar where benefits were not neutralized, U.S. goods and services exports still reached $1.62 trillion in 2007, shrinking the trade deficit by $46.9 billion from a year earlier.

Pass-through Rates More Intricate

If a currency falls by 10 percent and the cost of imports rises by 10 percent, the pass-through rate would be 100 percent. In turn, the weaker currency would reduce import demand and improve the trade balance. But today, many types of imports, especially consumer goods, typically have not become more expensive as the value of the dollar has come down. Why? In many cases, foreign exporters to the United States are biting the bullet, reducing their prices and accepting smaller profit margins in order to maintain U.S. marketshare.

From the mid-1970s through the 1990s, the pass-through rate was as high as 50 percent, according to The Wall Street Journal. This meant that a 10 percent drop in the value of the dollar would boost import prices by 5 percent. Recent studies indicate that only one-tenth to one-quarter of a currency depreciation now gets passed through as higher prices for foreign goods. This keeps inflation down, as well as the prices of consumer goods like clothes, that tend to be made abroad and consumed in large quantities in the United States. As a result, a continued drop in the dollar may be necessary to impact import prices and slow the American appetite for foreign goods.

The Grey Zone

In the past, a rise or fall in the value of the U.S. dollar had clearcut implications. Today, this is no longer the case. For example, although exports are up considerably due to the falling dollar, a steep decline years ago would have propelled exports to a greater extent.

Today, globalization, more efficient offshoring and infinite supply chain strategies are increasingly turning black-and-white assumptions grey.

This article appeared in Impact Analysis, May-June 2008.
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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, emerging risks, and the latest economic trends. He's also founder of both the ManzellaReport.com 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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