On the dollar’s fall
The U.S. dollar has fallen steadily in the 1990s. Then, it bounced back in 2000-2002. However, in the past three years, the dollar and Euro have reversed – you used to pay about $.85 for one Euro, now you have to pay about EU.76 to get $1. The reason is that the value is like any other asset – bonds, stocks, money market deposits. Its value is determined by supply and demand and the investors who look to make money in the foreign exchange market. 

On big investors, same motivation
These investors are not like you or I, they’re commercial and central banks, hedge funds and some big multinational companies. But they still invest with the intent of making money. IF they are expecting to receive higher rates of return on other currencies like the Euro, so the demand and price of the dollar falls accordingly. The two big things these investors look at are the interest rate and the inflation rate and their future expectations. A low interest rate or high rate of inflation means lower returns. 

On the current depreciation
In 2003, the U.S. economy grew faster than Europe’s, resulting in higher imports from the rest of the world. But, U.S. exports did not grow as fast, which resulted in a trade deficit. So, dollars flew out of the U.S. to foreigners. Historically, foreigners recycle these funds back to U.S., keeping demand for the dollar strong. But in 2003, they invested in other currencies like the Euro and Yen. Our government also said they wanted a weaker dollar, which turned foreigners further away from investing heavily in dollar-denominated assets like government bonds.

It didn’t help to have a record budget deficit as well. Foreign investors figured that the U.S. would have to borrow or print money to finance the deficit. If the U.S. chose to print, that would cause inflation and depreciation of the dollar. The result of all of this was that the dollar depreciated considerably in 2003-04. But, recently there’s been some good news about reducing the budget deficit and increasing interest rates, both of which will help the dollar gain some ground against the other major currencies.  

On big deficits and indifference
Right now, our trade deficit with China alone is more than $100 billion – we’re buying that much more than they are buying from us. And with the budget deficit, we are holding twin deficits, which is normally bad because sooner or later bills have to be paid. The Bush Administration does not seem to be particularly disturbed because those same countries with which we have trade deficits take the money from selling the goods to us and invest in our country’s stocks and bonds. As long as productivity and our output growth stay strong, others will probably have the confidence in the U.S. to pay its bills.

We’re lucky. The world has a tremendous trust in our system and in our economy’s future. If we were any other country in the world, the International Monetary Fund would make us change our policies, recommend belt-tightening policies to get out of this twin deficit situation.

On how it affects American businesses
Our exporters are really singing happy tunes right now because American goods are cheaper abroad so people are scooping them up in other countries. But obviously, it’s really alarming to importers. Also, American companies look cheap for foreigners that wish to acquire them. 

On foreign companies’ responses
I read in a German newspaper that it’s actually cheaper to buy a BMW in America and pay for it to be shipped to Germany than it is to buy one there in a lot. That’s because a number of foreign companies have not raised their prices in the U.S. because they don’t want to lose market share. So companies like BMW are keeping their prices low, suffering in profits because the cars are costing more to make, but really hoping the situation changes and the dollar starts to appreciate soon – they won’t be able to keep prices low for a long time. Eventually, they’ll have to reflect the true costs.  

On how it affects the average American
That’s hard to say across the board. If you buy a lot of imported goods like wine from France, you’ll start to feel that in your wallet. Everyone is seeing it in oil prices because a part of the reason the price of oil has escalated is that the oil market is based in U.S. dollars. If you’re traveling abroad, you’ll see it there too. But on the flip side of that, international tourism is up here in the U.S. because people from other countries can come for cheap. 

On balancing the deficits
The real way that this would right itself in the short run is if the Federal Reserve took an aggressive stance and increased the interest rates much faster and at a higher rate. Only that would start to get investors buying dollars again. But right now, it doesn’t seem like anyone in this Administration is too worried about it. In the long run, the dollar’s strength will only come from US economy’s strength. 

On the question of crisis
I don’t think it’s a crisis situation. My only concern is what if the foreigners who are continuing to invest in our country decided to invest elsewhere. That’s when we would have a major problem.