Don t Fear a Rising Dollar

While the renminbi has risen relative to the dollar, the dollar has declined against other major currencies.

So far, however, the RMB s appreciation against the dollar has been slow.

Would the price of oil have increased less if oil were priced in euros instead of dollars? Did the dollar s fall cause the price of oil to rise?

The coincidence of the dollar decline and the rise in the oil price suggests to many observers that the dollar s decline caused the rise in the price of oil.

In addition, a fall in the dollar could also push up inflation in the United States, leading to higher American and global interest rates.

One argument that economists use is that higher prices are due to the weak dollar.

Moreover, it is high oil prices that weakened the dollar, not vice versa.

With the euro rising relative to the dollar, the yen s fall relative to the euro has been even greater.

One of the problems that had made the crisis more difficult after 1982 was the US dollar s appreciation.

Such is the supposedly airtight case for a stronger dollar. How might it spring a leak?

This means that the dollar s 5 fall so far this year will add only half a percentage point to the inflation rate.

Indeed, America s current account position strengthened despite the dollar s appreciation in the face of safe haven demand.

Japanese intervention cannot explain the revaluation of the euro against the dollar and many other currencies.

Without a fall in the dollar and the resulting rise in net exports, a higher saving rate and reduced consumer spending could push the US economy into a deep recession.

The dollar would plummet. There would be financial distress and a deep recession.

In the short run, then, a US Treasury market crisis might lead to some knee jerk appreciation of the dollar.

Although occasional bouts of nervousness in global financial markets cause the dollar to rise, I expect that the dollar will continue to fall relative to the euro, the Japanese yen, and even the Chinese yuan.

But this time, with the dollar appreciating against other major currencies in recent months, the relatively fixed rate between the dollar and the renminbi has caused China s currency to strengthen in terms of its real effective rate.

The 20 revaluation of the renminbi against the US dollar in 2005 2008 undoubtedly facilitated this in the case of recipient countries whose currencies did not also appreciate against the dollar.

The yen s value against the US dollar has declined by more than 7 in the last month. With the euro rising relative to the dollar, the yen s fall relative to the euro has been even greater.

In sum, the fact that the US trade balance has defied gravity for so many years has made it possible for the dollar to do so, too.

But a sharply lower dollar would, at the same time, mean sharply higher inflation, requiring it to tighten policy.

That, in turn, has fueled sharp exchange rate appreciation and a loss of international competitiveness unless the affected central banks intervene to buy dollars.

The first answer, of course, is that the trade weighted dollar has fallen by more than 15 in real terms since its peak in early 2002. Yet the US deficits have persisted, and even risen, since then.

But this direct link between higher household saving and a lower dollar will only be forged if higher household saving is not outweighed by a rise in government dis saving, i.e., by a larger government deficit.

The financial sector was able to profit from the rising dollar, and a depreciation would have run counter to Ronald Reagan's administration's plans for bringing down inflation.

Their reduced demand for dollars will cause the dollar to decline and the trade deficit to shrink. That reduced trade deficit and the resulting decline in capital inflows will lead to higher real interest rates in the US.

If there is a sharp spike in interest rates caused either by capital flight in anticipation of a dollar decline or by tight monetary policy in reaction to a dollar decline comes to pass we will see how good the Federal Reserve really is.

The rise in the volume of dollars is causing the value of each dollar to fall relative to these currencies, whose volume has remained constant or risen more slowly.

Yet the rise in the euro, yen, and other currencies compensated for the fall in the dollar, preserving China s advantage.

The estimated decreased requirement of 33.9 million in respect of exchange rate fluctuations reflects the recent strengthening of the United States dollar after a period of weakening against a number of currencies.

These and other countries with very large foreign exchange balances are beginning to diversify their holdings from dollars to euros, a process that will continue and that will inevitably cause the euro to rise relative to the dollar.

The first answer, of course, is that the trade weighted dollar has fallen by more than 15 in real terms since its peak in early 2002.

In any case, protecting exports by resisting euro appreciation or, more precisely, dollar depreciation is a poor way to promote economic growth.

The high and rising price of oil does, however, contribute to the decline of the dollar, because the increasing cost of oil imports widens the United States trade deficit.

The Dollar

In the US, the inflation rate has also been depressed by the rise in the value of the dollar relative to the euro and other currencies, which has caused import prices to decline. This, too, is a level effect, implying that the inflation rate will rise once the dollar's exchange rate stops appreciating.

And, while the Chinese yuan has remained more or less unchanged relative to the US dollar in the past year, the dollar s sharp appreciation relative to the euro and other currencies caused the overall trade weighted value of the yuan to rise. This further depressed Chinese exports.

Fortunately, the market consensus concerning the dollar s inevitable rise as US interest rates increase is almost certainly wrong, for three reasons.

Now that the dollar has dropped 43 from its high against the euro, the process of global financial rebalancing is seriously underway.

As such, the Spanish dollar was worth slightly more than the U.S. dollar, and likewise, the Newfoundland dollar, until 1895, was worth slightly more than the Canadian colonial dollar.

A first reason to doubt projections of a stronger dollar is that none of the news on which they are based is really news. The expectation of relatively strong US growth is already being reflected in the markets, with the dollar up 9 in trade weighted terms since mid 2014.

Consider what a decline of the dollar relative to the yuan would mean for the Chinese. If the Chinese now hold 1 trillion in their official portfolios, a 10 rise in the yuan dollar exchange rate would lower the yuan value of those holdings by 10 .

The Return of the Dollar