Don't Sweat the Dollar
The recent fall of the dollar against the euro seems like a big deal only if you have a toddler's time horizon.
By Rob Norton
FORTUNE
Monday, August 12, 2002
American investors and business people have lots to worry about these days--from terrorist threats and looming warfare to corporate scandals that won't quit and stock market indexes that bounce around like pinballs. Fortunately the recent decline in the foreign-exchange value of the dollar shouldn't be on the list, despite some alarmist headlines.
First, although the dollar has declined sharply against other major currencies during the past few months, it is not low by historical standards. On the contrary, it's trading at exchange rates well above those prevalent in the 1990s. The real trade-weighted exchange rate of the dollar was 108.7 in July, compared with an average for the 1990s of 92.1 (1990 is the baseline). And at a recent 116 to the Japanese yen, the dollar was actually a little higher than its average exchange rate for the past ten years.
The fall of the dollar against the euro seems like a big deal only if you have a toddler's time horizon. The euro was launched Jan. 1, 1999, with its exchange value at about $1.17, and many Europeans were smugly confident that it would trade around that level or even rise. Instead it began a long, dismal slide. "Few people would have believed," wrote one Belgian economist in late 2000, "that in less than 1 1/2 years it would lose 25% of its value against the dollar." The euro fell all the way to 83 cents in 2000 before beginning its comeback, and at its recent rate of $1, it still has a ways to go before journalists begin referring to it as the "muscular euro."
One of the great macroeconomic mysteries of the past several years, in fact, was the seeming invincibility of the dollar, which continued to climb even as the U.S. economy slumped in 2001. Most economists felt it had become significantly overvalued, and a few months ago many forecast that it could fall as much as 20%. At recent levels it could easily sink another 10% against major currencies without appearing undervalued in historical terms.
Second, the dollar's fall isn't necessarily a bad thing for the U.S. economy. It's true that a falling dollar means that Americans are poorer, relatively speaking, and that a declining dollar tends to drive up import prices, which can fuel inflation. So far, though, import prices have barely budged, and inflation has been so low that the dollar would have to fall considerably further before it became worrisome on that score. It's also true that a real dollar rout--say, a quick, disorderly 25% decline from current levels--could depress foreign investment and imperil the recovery. But nothing has happened so far to make that scenario likely.
On the plus side, the falling dollar makes U.S goods more competitive in the rest of the world, which is good news for smokestack America. Manufacturers, which lamented the advantage a strong dollar gave foreign competitors, have cheered the recent fall. The National Association of Manufacturers estimated that the dollar's unusual strength in 2001 and early 2002 cost U.S. companies some $140 billion in lost export sales and resulted in a half-million layoffs (that's a third of all the factory job losses during the downturn). The falling dollar should give a further boost to manufacturing, which is already in the early stages of a powerful recovery.
Finally, whether or not we like the decline of the dollar, there's very little we can or should do to try to reverse it. Treasury officials can try to talk the dollar up--the crux of the government's long-standing "strong-dollar policy"--and can buy dollars or sell other currencies in the foreign exchange market, but nearly all economists agree that the effects of such actions are ephemeral. More substantively, the Federal Reserve could sharply increase U.S. interest rates, but that would imperil the overall economic recovery--something the Fed is highly unlikely to do as long as inflation remains low.
Ultimately, the exchange rates of currencies depend on what's going on over time in the real economies of nations. The reason the dollar rose so high in the 1990s was almost certainly that the U.S. economy was so strong: Innovation abounded, productivity increased at rates not seen in modern times, and GDP growth was higher than in nearly all other industrial nations. The U.S. was perceived as a great place to work, to build companies, and to invest.
Right now the U.S. is under attack--literally, by terrorists, and figuratively, by the fruits of its own excesses. But before you go betting your last euro on a continued deep decline in the dollar, ask yourself whether you really think innovation, productivity, and economic growth over the next decade are likely to be higher in Belgium--or in the U.S.
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