Introduction
What is a dollar? A dollar is the currency that is used as a medium of exchange in the United States of America. U.S. dollar has been used as the official currency of some other countries like Zimbabwe (due to high inflation).100 cents equals one dollar. (www.businessweek.com).The world currency is pegged on dollar in most cases especially in international trade (in oil industry, one barrel of crude oil is priced in dollars.
In other words, the dollar is the standard currency by which all other currencies are measured though China, Japan and the E.U. community are threatening this standardization due to problems facing the economy of the U.S. The dollar has continued to weaken against foreign currencies since 2005. Though it is weakening, the effect is not the same to major currencies. A weakening dollar is the loss of strength of the dollar as compared to other currencies-a situation also referred to as declining or falling dollar.
This means that U.S. citizens find imported goods and services costing more and exported goods and services going for less, that is, a dollar exchanges for more to other currencies to U.S. citizens. The weakening of the dollar is brought about by political environment and socio-economic factors. A weak or a falling dollar may not however, be a bad situation for a country’s overall economy and the effect (positive or negative effect) depends on where one is located relative to the country experiencing a weakening dollar. But since the U.S. is more opened up for trade than any other country, the effects of the weakening dollar seems to affect the world’s economy as a whole; countries that trade mostly with the U.S. are the most affected and the vice versa.
World’s Reserve Currency
A weakening dollar which is the currency that is pegged on almost any other currency becomes a threat to the world’s economy. This is due to the fact that people will start losing their trust on the dollar that is keeping on fluctuating. Foreigners buy assets denominated in dollars and they will feel that their assets are losing value and they would opt to change their investments and go to Europe or to Asia. This is due to the reason that a greater share of accumulated foreign exchange is pegged on dollar assets.
Though this is the case, American investors will borrow cheaply from outside and are able to invest more in foreign countries. At the same time, since the value of assets has really gone down, small businesses are faced with a threat of hostile takeovers by foreign investors.
Crises may arise when questions about the efficiency of the dollar to improve the overall welfare of lenders and borrowers start to arise. The fear that the fluctuations make affect the global economy is bringing alt of concern as to the future of the world’s reserve currency. Since foreigners keep their wealth in assets form whose future value is not certain, fluctuations in the dollar may not be comfortable with the investors. If the U.S. economy goes down this means that global economy likewise goes with it.
Real Spending
The real spending power of the Americans and other people using the dollar will decline. If the Americans are finding it expensive to consume imported commodities especially food commodities which they must consume, then their spending power is affected. This reduced spending power translates to a reduction in the real income. This is because consumers have to spend more to buy the same quantities than they previously spent. Importers will be the highly affected since they will be exchanging more dollars than equivalent foreign currencies. Consumers who are fanatics of Benz that is not manufactured in the U.S. will end up felling the pinch.
Lovers of French wine and clothes will have to pay more and hence their real incomes are affected. Foreign tourists will find America heaven since they are incurring less on flights due to the fact that foreigners are getting more than they previously exchanged for, students in Mexico will feel that courses abroad are being offered cheaply. Following this, Americans can earn massively from the tourist sector. At the same time local tourism will be encouraged since Americans find it difficult to travel abroad.
On the other hand, home remittances by foreign people to relatives and friends are affected by the weakening dollar. Currently for instance, in Australia an Australian dollar is exchanging for 77 cents. This is good for Australians getting remittances from abroad since for every one Australian dollar they exchange it with 77 cents which is quite okay to Australians. On the other hand, earlier, an Australian dollar was exchanging for 55 cents.
Hence, assuming that commodities produced domestically maintain their prices in dollars before the weakening of the dollar, more of these commodities can be purchased with each unit of the foreign currency. More of American commodities will be purchased by foreigners hence generating revenue and creating jobs in the U.S. Americans substitute domestically produced goods for items they used to import and hence improve the market of goods produced at home which follows the logic that the dollar is weaker and hence foreign currencies are more expensive, making goods priced in these currencies also expensive.
When the real spending power sores, the living standards rise. If this happens, the U.S. government is burdened with the responsibility of providing the basic needs to its citizens now that the cost of living has risen. Benefits such as retirement benefits, housing, medical care, transport and security have to be provided by the government.
America’s Balance of Trade
A country will most of the times enjoy great benefits economically when the balance of trade is in deficit though in the short-run. If the dollar is weakening, it is highly unlikely that a trade deficit will occur. Foreigners will benefit from cheap American produced commodities which will in effect help the Americans close the trade deficit. Contributing also to the closing of the trade deficit is the price of imports which have become relatively expensive to consumers.
Foreigners especially those in the manufacturing industry will have to raise their commodity prices so as to compensate for the weak dollar. Countries that export oil (OPEC countries) have to increase their oil prices such that they compensate whatever was lost in trading in dollars. Because almost all manufacturers have to use oil as sources of energy in their factories, definitely their produce must be priced highly.
Currencies that are pegged on the dollar like Yuan (China) are not highly affected by the weakening of the dollar since the U.S. market is large and extensive.
Countries like China, Japan, the U.K. and other newly developed countries who are export oriented, will be negatively affected since consumers in the U.S. find the goods and services imported being expensive. Consequently, these countries’ balance of trade will forever be in deficit since the U.S. offers a wide market for their exports. To avoid this, these countries may decide not to raise their commodities’ prices so as to compensate for the declining dollar. In doing so, these countries’ profit margins will be reduced and hence no developments will ever take place since mostly they did not make as much profits they would have needed for investment purposes.
Inflation
Inflation is the relative increase in price of commodities (goods and services) over time which results in production of excess currency and no equal in returns in commodity creation. Due to the increased cost of imported commodities inflation will rise in America.
High inflation will lead to the vicious cycles in the economy-high inflation will mean that interest rates have to rise. When this happens, the cost of capital goes up, investments reduces hence leading to laying off workers in industries and production declining. Since the government will not want this kind of economy the government lowers the interest rates. This kind of a scenario will create an environment of spending spree and a need for more money and eventual rise in inflation. This cycle will keep on repeating itself making the economy of any country to be unstable.
Interest rates to foreign investors on the U.S. assets will have to rise and consequently American consumers have to endure higher cost of capital for their borrowings.
Investment
Investors seem to like the weaker dollar due to translation. Due to the fact that exports become cheaper closing trade deficit, people are found new jobs (unemployment rate reduces). These found new jobs mean increased production and greater investments in a country. The weakening of the dollar will encourage investors both in America and internationally to invest in markets that are not related to America. Foreign earnings by multinationals get translated into U.S. dollars in a way that will make the earnings to be high.
American investors find it hard to expand their investments abroad since foreign investors are running away from the dollar and in fact they would like to invest in non-dollar currency countries.
Capital markets in the U.S. become attractive to foreign investors. This is due to the fact that interest rates have increased in the U.S. as the government try to fight the high inflation being experienced in the country. The attractiveness of America’s capital market is due to the fact that interest rate as determined by the central bank is based on the value of the securities. The weakening of the dollar will make investors to move to the East where the economies are doing well like in Japan, China, South Korea, Singapore and Taiwan.
The weakening dollar will drive home those industries that solely depend on imported raw materials since the cost of transport has gone up. It therefore means that every raw material or any other industrial input have to be manufactured internally, which is impossible (www.associatedcontent.com ). This might be a problem if the locals depended on that fallen industry for their livelihood.
Global Equity
Equity rises as the dollar drops, since Americans and international investors are encouraged to invest in non-American markets and thus regional balancing in terms of growth and development. With growth, people’s living standards rise and with development infrastructure is enhanced.
America will enjoy monopoly power since there is no pressure to keep prices of their commodities low and their commodities become competitive in the world market. High industrialization in America that is being favored by the weakening dollar is a threat to the green house accords that have been signed by virtually all countries in order to minimize climate change by decentralizing some of their high industries to different countries. Following the law of equity, America is not practicing equality.
Oil Price
The rising cost of oil can be attributed to the weakening dollar. Non-oil producing countries are requiring more dollars now to purchase a barrel of oil than they used to earlier before the dollar started to weaken. This will lead to situation where the government (congress) will be forced by public demand to introduce and formulate energy policies in America. Oil prices will continue to rise as long as the dollar is declining.
GDP
Dollar depreciation means that the commodities in countries that does not use dollar as their currency will be enjoying the fall in commodity prices and this will encourage their demand to rise. Weakening dollar may force the government of other countries, especially those that are ‘pegged’ to the dollar to induce a ‘stimulative monetary policy’. This tends to decrease interest rate which may trigger foreign demand.
Consumption
Weaker dollar will affect the consumption pattern of the US citizens. The price of imported commodities will skyrocket and consumers will be forced to choose local products. Traveling abroad will also be a costly affair. As a result citizens will have to cut down on their expenditure for touring other countries. The move will affect those countries that depend on US tourists in their tourism sector. The sector will thus receive fewer tourists which will also affect those employed in the sector and the GDP in general.
Dollarization
The global economy is emphasizing on dollarization (a situation where a country will officially adopt another currency of another country for all its financial transactions). This will require the dollar to have minimal fluctuations, that is, the currency must be stable, in order to reduce sudden and sharp revaluations and devaluations. This will allow countries to enjoy high levels of trust and have their risks diversified hence more globalization and growth. Following the weakening of the dollar, this may not materialize since other currencies may be a better option than the U.S. dollar.
Exports and imports
The EU markets view the weakening dollar as a threat to its trade. The exports by the American people will mean increased profits to the U.S. citizens while at the same time reducing imports from its trading partners like the Japanese who are export oriented economies. For instance it will be disastrous to Japanese whose major market for its exports is the U.S. The continued fall in the dollar will mean that Americans will find Japanese goods and services costing more than their own products that are manufactured in America.
If this continued, most of these export oriented nations will continue facing a never ending balance of payment deficits since the imports will have outweighed the exports. The focus of trade of these countries will now turn to Europe, Asia and Africa.
Owing to the fact that most of the third world countries especially in Africa are turning to the Asian tigers for donor aid, Africa will be left with nothing to be offered by these countries since they can barely sustain themselves leave alone helping other countries. In effect Africa will remain in this state of economic backwardness for as long as they can be able to withstand the high cost of the western aid.
On the other hand traveling will be much hard for the Americans which will translate into low levels of tourists coming from America. There are those countries whose economy is dependent on tourism. For such countries, they have to find other means of sustaining themselves economically since they are losing a lot from American tourists. Of all the tourists who visit Israel, the highest percentage of these tourists especially during summer is Americans.
The weakened dollars will not them when they travel. Tourism industry in Israel is based on dollars; airline bookings, hotels and everything else. Due to many tourism attractions that Israel is endowed with, Israel becomes a much cheaper alternative because the dollar will exchange for more. The only threat to this status quo is the security concerns in Jerusalem. Reports are showing that the numbers of Americans in Israel are up of all times in history. Though this is the case, it is one of the exceptions where the weakening dollar has no effects on other economies but it must be noted that the situation is like this in Israel since their currency is pegged on the dollar and hence the Americans are advantaged since they are also using dollars.
Employment
As Americans continue to enjoy falling levels of unemployment due to rise and expansion of industries in the country, other nations around the world will continue to worry about what to do with the jobless people. American dollar weakening is only creating the markets for its own citizens. Their standards of living will go up in America while those of their counterparts continue to decline.
Unemployment will lead to rise in crime and backward developments in economy.
Exchange Rate Regime
Since 1973 when the fixed exchange rate regime collapsed, the exchange rate of the dollar has continued to be determined by the forces of demand and supply in the market. The flexible or the floating exchange regime is not controlled by any party but the market sets the rate at which the currencies are exchanging. The weakening dollar on which it is the world’s reserve currency is leaving some doubts as to whether the market forces should be left to operate on their own or some intervention is needed in order to minimize the fluctuations.
Interest Rate
A weakening dollar also means that there will be increase in capital inflow. This translates to an influx of foreign investors. As more foreign investors enter the US market, there will be more demand of loanable funds which will results to reduction in its supply and this will affect the interest rate which will increase.
Elwell, a specialist in macroeconomic policy, government and finance policy with Congressional Research Service argue the following:
Slowing capital flow reduces the supply of loanable funds available to the economy and tends to increase the price of these funds, interest rate. Foreign countries will be experiencing capital outflow as majority of its investors will be transferring their capital to invest in US. Capital outflow will make the demand of financial assets in the foreign countries to fall; hence there will be high supply of financial assets in the market (foreign countries).
This means that the price for these financial assets will decline as supply overcome the demand. A rise in investment level in US economy may lead to transfer of capital from foreign countries to US. This will encourage depletion of investment in foreign countries as many investors will prefer to produce their products in US and export back home, cross-subsidization will take place in foreign countries.
Works Cited
A Weak Dollar Is Bad For America. Web.
A Weak Dollar: How it affects the US and Why Our Leaders want it. Web.
Craig K. Elwell, ‘Effects of Weakening Dollar’,Congressional Research Service, 2008. Web.
The Pros and Cons of a Weak Dollar. Web.
What is a weak dollar. Web.