The Consequences of a Weak Dollar

Currency values are used as a benchmark, or measuring standard, for the welfare of a nation. Additional supply and a general lack of confidence pertaining to the welfare of the United States of America adversely affect valuations of the U.S. Dollar. Weak dollars impact international trade, inflation and the U.S. political climate when Americans believe that leadership is mismanaging foreign exchange and the nation, at-large.

Increased Supply

Basic economics articulates that the increased supply of any asset leads to falling prices. To state the obvious, a weak dollar is typically the consequence an increased supply of liquidity. The Treasury maintains the power to tax, or simply “create” money by running the printing presses. The Federal Reserve Board (Fed) manages interest rate policy by buying government debt. The Fed actually injects fresh dollars into the financial system while doing so. The federal funds target rate is now effectively zero.

Traders monitor U.S. deficits, or official money that is owed to international governments and domestic government spending. The value of the dollar falls when people realize that the Federal Government must again create money to make good on these debts, or even default, which would be catastrophic. In recent times, Argentine, Mexican and Russian debt defaults led to a near collapse in currency values.

Inflation

Devalued currency leads to inflation, or elevated price levels. Purchasing power falls because more dollars are required to compensate the sellers of goods for their wares. In particular, weak dollars lead to expensive prices for commodities and imports. Steve H. Hanke, Johns Hopkins University applied economics professor, recently credited weak dollars as the driving force behind today’s secular oil price boom.

International Trade

Weak dollars do support to the U.S. export economy. Corporations that transact international business and merchants that sell goods overseas are able to effectively undersell competitors. The cost of domestic production – priced in weak dollars is relatively cheap, in relation to foreign exchange. Additionally, exporters are paid in valuable foreign currency, which translates into increased profits and purchasing power when converted into U.S. dollars.

Meanwhile, foreign importers would have difficulty selling their goods in the U.S. if the dollar were to decline further in value. Foreign goods become expensive because retailers must earn more dollars as adequate compensation for the lost purchasing power.

Politics

Confidence inspires Americans and foreigners to purchase goods, hire employees and invest within the stock market. These activities increase the valuations, and demand for dollars. Conversely, the lack of confidence causes business activity to stall and lessens the demand for dollars. The price of any asset falls when demand is weak.

Americans pressure politicians when weak dollars lead to high levels of inflation and a general lack of confidence. The unrest may lead to reforms that support the dollar and a reversal of current policy – where deficits are paid down and interest rates are raised to effectively take dollars out of circulation.