A Dilemma for the Dollar

Excerpt from Raymond James Economist Dr. Scott Brown's latest economic commentary:

The dollar’s decline has been both a consequence and cause of financial market concerns... Is this the end for our dear friend, the world’s lead reserve currency? No, but the dollar may not recover for a while...

The trade deficit in goods and services has declined in inflation-adjusted terms, adding to GDP growth in recent quarters. However, the nominal (that is, current-dollar) trade deficit hasn’t budged much recently. That’s because higher oil prices are offsetting the impact of decreased demand for non-petroleum imports. The petrodollars (dollars paid for oil imports) return to us somehow, either through direct investment into the U.S., through increased purchases of U.S. financial assets, or, if these are insufficient, through a weaker dollar. Thus, higher oil prices may have a tendency to weaken the dollar further, adding to the already-high price of oil.

So what’s the appropriate policy response? Remember that the exchange rate of the dollar is the Treasury’s responsibility, not the Federal Reserve’s. Currency intervention would be small relative to the overall size of the foreign exchange markets, but could provide a “slap in the face” to get people to calm down. While the Fed has no say on the dollar, a weaker currency does have some implications for inflation. However, imports still are a relatively small portion of the overall U.S. economy. Inflation pressures have not taken root in the labor market, nor does that appear likely to happen anytime soon.

...Ultimately, the U.S. economy will recover and the rest of the developed world is likely to slow, but it will take some time for the current situation to play itself out.

Comments

[Mr. G]

I believe the experienced forex trader will tell you currency markets trade on sentiment and of course the direction of trade is determined by the majority of traders betting in one direction. The euro has lost 5 cents against the dollar recently. From the indicators recently emanating from the US, I have not seen an indicator that supports such a move other than the FED and treasury have taken some innovative tactics other than printing money to slow down the dollar retreat. The market has perceived this shift in policy and given the dollar a reprieve. The major question is whether the dollar will continue to rise against its paired sisters on the forex.
I think the answer is not visible until the mortgage market unwinds and traders can determine the depth of decline in the GDP of the US. Prediction at this point is a guess, but the data dependancy of forex will tell as time unravels the details. As far as the U.S., I havent heard any fat ladies singing yet.

[swimjames]

Dr. Brown: do you really think a one month credit card cycle vs. cash spent today will make a difference in economic impact?? Sounds like you may have something from the 70s still in your system. A friend of mine really wants to know so please respond..