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November 18, 2000 In afternoon trading, the euro bought $1.155, its highest level ever against the U.S. currency. In early-morning trading, the euro was at $1.174. The dollar was fetching 108.05 yen, nearly a full yen weaker than its early-morning level of 10.08. (CNN/Money) Why did this happen?
At the time of introduction of Euro it was thought that it might not be able to make the desired impact to lessen the importance of US Dollars in the International Trade Market. Whereas the present scenario depicts a different situation in which we find Euro appreciating in value and US Dollar losing its value steadily.
· The collapse of the dotcom market in March, 2000
· The terrorist attacks of September 11, 2001
· A wave of stock market scandals, where senior management falsified financial statements of companies that were performing poorly, while selling off large portions of their stock. When the deception was discovered, the stock price fell, causing huge losses to the average shareholder who wasn’t in on the deception.
· Impact of the war with Iraq on consumer confidence.
These events precipitated an economic downturn for the United States, which had already gone through a mild recession - defined as two quarters of negative growth in a country’s Gross Domestic Product (GDP) in early 2001. Consumer spending, which makes up over two-thirds of the US GDP, slowed during the recession, and then dropped significantly after the terrorist attacks. In 2000, they fell again due to concerns over the impending war with Iraq.
In the current climate of uncertainty, businesses are reluctant to invest in new projects, while consumers - many of whom borrowed heavily to invest in the stock market, only to suffer severe losses - are reluctant to spend. Production levels have fallen, while unemployment figures are rising. In March 2000, the United States had the second largest trade deficit on record. (The value in dollars of the goods and services the United States purchased exceeded the dollar value of the goods and services it sold abroad).
What does a falling dollar mean to you, the average consumer or investor, besides a rate of return on your hard earned, deep discounted bucks? Well, if you're planning to go to Europe, the lop sided exchange rate is going to sting a lot. If you're staying home, prices are relative, so the pain is not apparent. The sharp drop in the dollar, though, is an extremely bad sign for the broad picture and mark of judgment by the Europeans and the world on the current state of the American capitalism about six out of ten, and backtracking. Your mass of dollars in the bank, has lost about 15% of its total net worth over the last three years - on top of the crumby interest rates the bank is dropping on you.
A terribly weak dollar trading at a 0% to 5% discount (CNN/Money) to the other major world currency is a sign of severe economic distress not a prelude to any recovery. One of the few things that will strengthen the dollar is a growth in the economy, and a bump in the stock market.
GDP has risen higher then expected in the end of the third quarter of 2000. The dollar is not getting the lift that would be expected from data showing that the American economy grew very fast in the third quarter and is expected to have a good performance in the last three months of the year. That lift can act as a key stabilizer for the dollar, preventing it from falling too fast and too far.
Another reason to worry that the decline may pick up pace is that some European officials are now saying that a stronger euro is not a problem for them, a switch in recent sentiment. Wim Duisenberg, the outgoing president of the European Central Bank, made such a remark last week, saying he was not worried about the euro's current strength against the dollar, according to Bloomberg News. These kinds of comments are usually taken by foreign-exchange traders as openings to sell dollars.
The weakening currency helps U.S. businesses against foreign competitors by making U.S. goods cheaper in comparison. But it makes imports and foreign travel more expensive for Americans. Fears about the U.S. trade and budget deficits - factors that can undermine a countrys currency - continued to weigh on the dollar as they have for months.
So, will the dollar rise in 2004?
The US dollar has been extremely volatile against the euro over the last few months. After depreciating steadily from April 2000, dragged down by weak growth and a large current-account deficit, the dollar rose against the euro between May and September 2000 as financial market participants hoped for a strong US economic recovery. Then fears over the US current- account deficit took over again and the dollar dropped back, reaching US$1.18 euro1 by mid-October. Although the strong third-quarter GDP data may give the dollar yet another brief respite, I believe that the large current-account deficit, combined with the fact that investment returns in the US (while certainly improving) will remain well below those in the late 10s, will lead to the dollar dropping further, reaching US$1.5 euro1 by the first quarter of 2004. The currency should be able to appreciate gradually from this level from the second half of 2004 as the US economic recovery starts to look better balanced (with private-sector demand taking over from fiscal easing as the main source of growth).
Economists are divided over the effect of the large U.S. deficits. Some say that a fundamentally strong U.S. economy will continue to attract investors from overseas. Those investors have to buy dollars to get into U.S. stocks and bonds - driving up the currency and, in theory, offsetting the effect of the deficits.
They also see the euros rise more as a story of dollar weakness than newfound confidence in the joint currency, since the dollar has fallen recently against the Swiss franc and the pound, which hit a five-year high Friday against the dollar at $1.740. In midday trading in New York, the pound was worth $1.70. (Newsday.com 11/8/0)
What are some of the advantages of US dollar depreciation?
The fall of the dollars had a positive effect on US manufacturers. The goods become cheaper to export and, therefore, easier to export. They are convinced a weaker currency will help them compete overseas and save US jobs. Already, import prices are beginning to rise - making it easier for US producers to compete with foreign goods in the domestic market.
While the manufacturing sector has begun to show signs of life after years of decline, analysts believe the real boost from the dollars decline will come in 2004, once export contracts roll over and new, lower prices are set for US goods overseas. US companies, meanwhile, are benefiting in two ways. First, the weaker dollar is making their products more competitive in foreign markets and boosting sales. And second, since foreign currencies buy more dollars, their revenues rise further when they convert foreign receipts into US cash. Also an advantage, foreign investment and travel become more accessible due to weak US currency.
When the Euro was first introduced in early 2001, investors were doubtful about its viability, forcing it down steadily. Meanwhile, the US dollar’s role as the world’s reserve currency strengthened. Central banks worldwide hold various currencies as reserve assets, but the US dollar climbed from 57% of total reserves in 15 to 68% in 2001.
Will the US continue with the Economic
Leadership ? Will it lose its domination to China? The world is watching.
One way to acheive that, are a drastic reduction in the deficits. Cutting income taxes is a nineteenth century prescription for a faltering economy. It is like a nineteenth century quack prescribing mercury and opium for a host of ailments. The opium killed the pain, and the mercury.
The dollar was remarkably stable against the yen while it was gyrating against the euro, largely because the Japanese authorities were intervening aggressively to hold the value of their currency down. However, after the G7 meeting in late September (after which a statement was issued making a vague call for more flexible exchange rates around the world), the Japanese authorities allowed the yen to surge.
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