Experts: Don't fear the weak dollar
The dollar keeps hitting new lows against the euro. But some say this won't hurt the economy unless the greenback enters a prolonged slump.
NEW YORK (CNNMoney.com) -- Concerns about the weak dollar are mounting. But even as the greenback sinks to new lows against the euro and other global currencies, some experts say this is not necessarily a bad thing for the U.S. economy.
The anemic dollar does pose plenty of hurdles for an economy that some argue is already in a recession. Most notably, the weak dollar is raising more fears about the very visible impact of higher inflation.
Textbook economics suggest that a weaker dollar forces consumers to pay more for imported goods like toys made in China or a bottle of wine from France's Bordeaux region.
Moreover, it also drives up the cost of commodities priced in dollars. And unless you've been living under a rock lately, that's already happening across a broad range of commodities including wheat, gold and oil, which now hovers at record levels just below $110 a barrel.
But the inflation fears may be a bit overblown.
Late last week, Federal Reserve Governor Frederic Mishkin said in a speech that the dollar's decline only poses a limited inflation threat to the United States, arguing that there is little correlation between consumer inflation and changes in the exchange rate.
Still, there are other reasons to be fearful of a weak dollar. If it declines further, it could erode interest by international investors in buying dollar-denominated securities.
Although many foreigners are still buying more U.S. securities than they are selling, there are signs that some overseas investors are slowly shifting away from assets tainted by the greenback, such as U.S. Treasurys.
According to the most recent Treasury International Capital report, a monthly reading on foreign investment flows, net foreign purchases of long-term U.S. securities were $69.1 billion in December, down from net purchases of $70.3 billion in November and $118 billion in October.
If this trend continues and overseas investors actually start dumping more securities than they acquire, that could hurt the economy as a sell-off in Treasurys would lead to higher long-term bond rates. That would be a problem since longer-term bond yields have an influence on mortgage rates. Bond prices and yields move in opposite directions.
"Foreigners continue to buy U.S. securities," said Jay Bryson, global economist with Wachovia. "If there was a massive exodus, you would see a major impact on Treasurys."
The economy and exports
But two key factors temper economists' fears about the lasting impact of a sunken dollar: a surge in exports and expectations that the economy will begin to show signs of the growth during the second half of the year.
The dollar has helped lift sales at U.S. manufacturers that export their goods, including large multinational companies like Boeing (BA, Fortune 500), General Motors (GM, Fortune 500) and Apple (AAPL, Fortune 500). Trade numbers published Tuesday by the Commerce Department showed that exports jumped 1.6% percent in January.
And with some economists and policymakers, including Federal Reserve Chairman Ben Bernanke and Treasury chief Henry Paulson, talking about the economy bouncing back during the second half of 2008, that should also be good news for the dollar.
That's because the Fed would probably stop lowering interest rates if the economy shows signs of resuming a healthier level of growth. Many on Wall Street say the Fed's rate cuts are partly to blame for the weak dollar because lower short-term rates have helped fuel the rise in oil and other commodities and undermine confidence in the dollar.
But right now, the near-term outlook for the dollar is still troubling since some pretty ugly economic numbers likely lay ahead.
"You don't have to be a rocket scientist to see how many issues the domestic economy has right now," said Benedikt Germanier, currency strategist at UBS.
Currently the dollar is trading around $1.54 against the euro and some currency strategists anticipate the greenback could shatter the key psychological mark of $1.60 against the 15-nation currency in the next month or two.
Wachovia's Bryson warns that if the dollar hit that level as the result of a sudden move, that would be a big deal as it could force already skittish foreign investors to dump their dollar-denominated securities. But if the dollar were to gradually move towards the $1.60 range in the next few months, he does not see this as a problem.
Even the most bearish currency experts suggest that the dollar should recover against the euro later in the year if the sluggish U.S. economy starts to pick up and the Fed winds down its rate-cutting campaign.
But some experts worry that if an economic rebound doesn't materialize later during the second half of the year, the dollar would remain under pressure, limiting the appeal of assets like Treasurys to foreign capital.
"If the dollar would stay this way over a period of several years, it would be a negative," said David Resler, chief economist at Nomura Securities in New York.