Is the dollar's latest dive anything to be afraid of?
From Wall Street to Washington, the answer has been a resounding "no." Economists, traders and business leaders have been cheering loudly, saying a decline in the currency is long overdue, boosting the ability of U.S. producers to compete in a tough global environment.
Few take seriously the Bush administration’s occasional pronouncements that it still favors a “strong dollar," and even Fed Chairman Alan Greenspan gave a nod of approval to the trend in a high-profile speech in Europe last month.
The dollar’s decline “is medicine needed to promote the healing of global imbalances,” said J.P. Morgan Chase senior economist Bruce Kasman in a commentary titled “Two Cheers for the Dollar Decline.”
But for consumers, that medicine could be hard to swallow, especially if the dollar’s decline turns into a free fall. That could spark a run-up in inflation and force the Federal Reserve to raise rates aggressively, potentially bringing down the high-flying housing market.
“A weaker dollar, generally speaking, is better for business and bad for consumers,” said Mark Zandi, chief economist of Economy.com, a forecasting firm.
“If the dollar’s decline is orderly, then inflation will rise, but very modestly,” he said. “In a darker scenario, the process is not smooth, interest rates rise more and the pain we feel will be more significant, in large part because of problems in the housing market. The housing market will get crushed, and that will reverberate through the economy.”
Dollar’s slide accelerates
The dollar has been losing value steadily for nearly three years, but the slide has accelerated in recent weeks, with the currency passing fresh milestones almost daily against the euro, the Japanese yen and the British pound. Since late August the dollar has lost 9 percent against a basket of major currencies and has tumbled even further against the euro, which now costs about $1.33, compared with $1.20 three months ago.
So far consumers have barely felt the impact — unless they have been to Paris lately and had to pay $5 for a cup of coffee. But Wal-Mart’s failed experiment with less aggressive discounting last month could be a hint of things to come, especially if China allows its currency to appreciate against the dollar, which could happen early next year.
That will be a “seminal event,” Zandi said. “All retailers will have to rethink their pricing policies,” he said. “Given their already-thin margins, they will have to start raising prices aggressively.”
Zandi is not the only one to express concern about the ripple effect of a falling dollar on the housing market.
Paul Kasriel, economic research director for Northern Trust, has been outspoken in his fear of a housing “bubble” that cannot be sustained by the normal fundamentals of wage growth and household formation.
“Housing has never been more leveraged than it is today,” he said. And millions of homeowners are badly exposed to rising interest rates through the explosion of variable-rate mortgages, he said.
A dollar collapse could be just the thing to prick a housing bubble, Kasriel said.
If that happens, “we could have some significant problems in the banking system,” he said. “Historically a weak banking system has coincided with a weak economy. That is kind of the doomsday scenario.”
Rosier outlooks
Most market economists dismiss such gloomy speculation. Don Straszheim of Straszheim Global Advisers noted that the core inflation rate is still a very reasonable 2 percent. “If we were at a 4 or 5 percent inflation rate and headed higher, this dollar decline would be far more troubling to a lot of people,” he said.
He and others also largely dismiss concerns that the central banks in China and other Asian countries will stop purchasing Treasury bonds and other dollar assets the United States needs to sell to keep funding its massive current account deficit, now running at a rate of more than $650 billion a year.
A recent article in the Economist magazine contended that the dollar is on the brink of losing its global hegemony because of U.S. finances that “look more like those of a banana republic than an economic superpower.”
“You need an alternative,” said Joseph Quinlan, chief market strategist for Banc of America Capital Management. “I don’t think it is the euro. It’s not the yen or the yuan. By default the dollar is the world’s currency for now.”