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Weak dollar 101
Currency worries Fed, affects everything from mortgage rates to retail prices to jobs. Here's how.
November 19, 2004: 1:48 PM EST
By Chris Isidore, CNN/Money senior writer

NEW YORK (CNN/Money) - For most Americans, a record low for the dollar doesn't have the same urgency as soaring oil prices or a big tumble in the stock market.

But the dollar is important to economists and policy-makers.

Fed Chairman Alan Greenspan, for example, warned in a speech in Europe Friday that two of the things weakening the dollar -- the trade deficit and the budget deficit -- should not be allowed to fester too long. But even the Fed has relatively few tools at its disposal to address either deficit directly.

In fact, the value of the dollar has a big effect on almost everything in American life, from the price of consumer electronics to mortgage rates to the job market. And it has a big impact on whether a vacation overseas is more affordable for Americans or Europeans.

The causes of the weak dollar are many, but economists agree on some major factors. And the general consensus is that the dollar won't strengthen that much in the foreseeable future.

What causes weakness

The two factors most often cited are those mentioned by Fed Chairman Greenspan -- the twin deficits. The United States has run a trade deficit with the rest of the world for many years. And it has funded deficits in the federal budget by selling ever growing amounts of debt, a large chunk of which are bought by foreign investors seeking a safe place for their money.

In the past, the dollar could stay strong despite the twin deficits, given enough demand for U.S. stocks and government debt from foreign governments and investors.

But in recent years the growing trade and budget gaps have outstripped the flow of foreign dollars into the United States. Low interest rates have also slowed overseas investments here. And Greenspan said Friday that if the nation's deficit in goods and services keeps rising, and the dollar weakens further, that will eventually limit demand for U.S. assets from overseas.

Bush administration officials have generally spoken out in favor of a strong dollar. But currency traders have interpreted the administration's actions -- as compared to its words -- as favoring a weaker dollar.

Besides running up the federal deficit, the administration has pushed hard for less intervention by Asian governments to keep their currencies weaker against the dollar.

How weakness hurts the U.S.

If the weak dollar further curtails foreign investment in the United States, that could force up yields on government bonds, because higher rates would be needed to attract investors. And bond yields have a direct impact on the cost of money for business and consumers, including mortgage rates.

The weak dollar also means many goods produced overseas with little domestic competition -- such as clothing or electronics -- could end up costing more here. And if Americans keep buying higher-priced imports, that could lead to an even larger trade deficit, which in turn would put further pressure on the dollar.

What's more, U.S. companies that buy raw materials and parts overseas would see costs rise in dollar terms. But if they can't raise prices for their products, that could cut into profits and perhaps, hiring.

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Another way the weak dollar has hit U.S. consumers is by putting upward pressure on oil prices. Oil contracts are priced in dollars, so the weaker dollar has forced oil traders to seek more dollars for oil, since buyers in Europe and Japan have a stronger currency to use when bidding for the same limited supplies.

One of the most direct effects: Americans traveling abroad would find prices for just about everything higher.

How it helps

There is some upside to dollar weakness, since many big U.S. companies get a bump in sales overseas, where their products become more competitive. For example, Procter & Gamble reported sales grew 3 percent in the third quarter due strictly to changes in currency exchange rates, bringing in an extra $365 million in company coffers.

And manufacturers such as U.S. automakers typically cheer a weaker dollar, even though the weakness tends to benefit producers of commodities such as steel more than makers of finished products such as autos.

U.S. tourism is another industry that can see a lift. Foreigners are more likely to visit since their currencies can buy more here, and U.S. vacationers who might travel abroad are more likely to stay home if dollar weakness makes overseas travel too costly.

What's next?

"The consensus among currency traders for a continuing weakening of the dollar is overwhelming," Ashraf Laidi, chief currency analyst for MG Financial Group, said recently. Laidi and others see relatively little on the horizon to help the dollar, though its declines may not be as severe going forward. Laidi sees the euro buying $1.31 or $1.32 or so by year-end.

Tom Schlesinger, executive director of the Financial Markets Center, said that unless one of the "twin deficits" shows signs of shrinking, there's little that would lift the dollar.

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"Traders would want to see a drop in the price of oil (which could narrow the trade gap) or some major policy move in Washington that they would take as a serious sign of deficit cutting," he said last week. "If you had to handicap the two, a drop in oil prices is somewhat more likely."

The trade deficit could also decline if China allows its currency, the yuan, to move more freely, rather than being linked to the dollar. Such a move is possible late next year or early in 2006, some economists said.

That would make Chinese goods more expensive and limit Chinese exports to the United States, which has its largest trade gap with China. But in the short run, a floating yuan would probably put additional downward pressure on the dollar.  Top of page

-- This is an update of a story that originally ran Nov. 10

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