IE 11 is not supported. For an optimal experience visit our site on another browser.

If economy is healing, why is the dollar falling?

The U.S. dollar spiked when the economic crisis was peaking, and it's falling now that a recovery's in sight. What gives?
/ Source: The Associated Press

The U.S. dollar spiked when the economic crisis was peaking, and it's falling now that a recovery's in sight. What gives?

The relationship between the country's economy and its currency, it turns out, is more complicated now than ever as the government assumes a larger role in propping up the financial system and encouraging economic growth.

Here are some questions and answers about why the dollar has weakened, how much farther it could fall, and what it means for the average American.

Q: How much has the U.S. dollar dropped?

A: It's moved differently versus different currencies. But the U.S. Dollar Index, which measures the dollar against a bunch of other major currencies, is down about 10 percent from early March — when the stock market hit a 12-year low.

The currencies the U.S. dollar has fallen against include the euro, the Australian dollar, the Canadian dollar, the British pound and the Mexican peso. That means visiting Australia, Canada, Mexico and most of Europe will be a bit more expensive now for American travelers than earlier this year.

The U.S. dollar index is still up, though, from a year ago.

Q: Why is the dollar retreating?

A: It's partly because the U.S. economy is weak. Usually, a currency is regarded as a barometer of a country's economic conditions, or standard of living. But even more so, the dollar is falling due to the nation's growing debt.

The dollar actually gained in value versus rival currencies when jitters about the U.S. economy were peaking in the six months leading up to March. That's because investors were even more worried about other countries' economies, which tend to lag the United States.

But as the months wore on and the Treasury Department continued to issue record amounts of government bonds into the market to finance its stimulus and bailout packages, the dollar has become less and less attractive to investors. The U.S. budget is expected to hit a record high of $1.84 trillion this year.

A poor economy and high debt weaken a country's currency because investors decide that they're better off buying bonds, stocks and other assets in countries with stronger economies and more stable debt. Stronger countries' assets — and, thus, the currencies those countries use to value their assets — are more likely to rise in value, and their debt is less likely to default.

The dollar took an especially hard hit last week, after Standard & Poor's said Great Britain's swelling debt might force the credit agency to lower that country's credit rating. The agency's warning raised worries among investors that the United States might see its own credit rating lowered.

Q: What would if mean for the U.S. economy if the country lost its triple-A rating?

A: Interest rates would rise for debt ranging from Treasury bills, bonds and notes — investments in U.S. debt — to mortgages and car loans. Basically, it would be harder for the nation to raise money to pay for its economic recovery plans, and it would weigh down already debt-laden borrowers with even more debt. And it could make investors more nervous, too, causing markets to become more volatile.

Q: How probable is a rating downgrade for the United States?

A: It depends who you ask.

Many analysts, including Harris Private Bank chief investment officer Jack A. Ablin, say it's unlikely. The United States has always had a triple-A rating, the highest possible, which means there's very little chance the country will default on its debt. Moody's, which said Wednesday its triple-A rating on the U.S. government was stable, has been rating the country's debt at triple-A since 1917. The Great Depression didn't even prompt a downgrade.

But more and more respected investors, notably bond fund manager Bill Gross, are starting to say that the United States' rating is vulnerable.

Not even Moody's senior credit analyst Steven Hess would rule out a downgrade. He said Wednesday that if the government's debt ratios — the amount of debt relative to the amount of economic activity in the country — keep climbing even after the recession is over, the credit agency will have to revisit its rating.

Q: What are the chances of a sharp dollar plunge?

A: The financial crisis has taught us to never say never. But it's important to remember that currency values are all relative. The dollar doesn't just fall in a vacuum; it falls versus the euro, the pound, the yen, or other currencies. As bad as the U.S. economy is right now, many other major economies, particularly in Europe, are much worse off.

Ablin likened the dollar maintaining its value to a camper escaping a bear: "We don't need to outrun the bear — we just need to outrun the other campers."

And so far, the United States hasn't run into any problems issuing debt. That suggests investors around the world still have confidence in the currency and the country's ability to pay back its debts.

Q: Why would a dollar decline be so bad, anyway?

A: Actually, to the government, a moderate dollar decline isn't scary at all. A weaker dollar appears to be what the Federal Reserve was aiming for when it slashed interest rates, said Axel Merk, chief investment officer of Merk Mutual Funds.

A devalued dollar is cited by many economists as the big reason the United States was able to recover from the Great Depression in the 1930s.

The U.S. economy also benefited from a relatively weak dollar in recent years. Why? A weak dollar makes U.S. goods cheaper to consumers in foreign countries, which helps U.S. companies sell more stuff.

But a precipitous drop in the dollar would be detrimental. Not only would it signal severe instability in the U.S. economy, but it could have negative implications for the stock market and the government's efforts to fix the financial system.

Financial analyst Richard Bove at Rochdale Securities noted that in the unlikely event of a significant plunge in the dollar, banks and the stock market could return to crisis mode. That's because bank stocks are valued in dollars, and so are the investments the government has made in banks.