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The reasons and consequences of the fall of the dollar

Two economists discuss the dropping value of the dollar and the impact it could have on the global economy. Since this summer, the value of the U. Dollar has dropped about 9 percent against other major currencies. Yesterday, it hit a new low against the euro, and its value has dropped more than 40 percent against the European currency since 2002.

One dollar is now worth only about three-quarters of a single euro.

Reasons for the Dollar Decline and the Effect on the Global Economy

Economists say the decrease is due in part to two big deficits in the U. First, there's the U. And there's the broadest measure of the U. That's the shortfall on trade and investment income between the U.

For more, we're joined by Kenneth Rogoff, a professor of economics at Harvard University, and former chief economist and director of research at the International Monetary Fund.

Why is the US dollar falling?

And Irwin Stelzer, director of economic policy studies at the Hudson Institute. Professor Rogoff what does it mean to say the dollar is down against another currency? Well, put simply, it means that if you take your dollar to a bank and ask for say euro or yen, you get less than you would have otherwise.

It also means that if somebody from Paris or Berlin comes to New York, they think everything is pleasantly cheap. But if one us goes over there, it's suddenly looks really expensive. Irwin Stelzer, does that thumbnail description work for you?

Yes, it does, of course it also has business implications. It means if an American business firm goes to buy a European company, they'll have to shell out more dollars to get that company. And it also means that American companies are cheaper if there are acquirers abroad who want to buy American companies. And, Irwin Stelzer, why is this happening right now? I think it's happening primarily because we are buying more stuff from the rest of the world than the rest of the world is buying from us.

As long as that goes on, we're shipping over to other countries pictures of American presidents on little bits of paper and they're sending us automobiles and T-shirts. At some point they don't want any more of our pictures of American presidents, and so they begin to be willing to pay less for them. Why do you see this happening, especially right now? Well, it's been building up for a long time, the United States has been borrowing, and borrowing, and borrowing, and if we were a developing the reasons and consequences of the fall of the dollar, world capital markets usually give us enough rope to tie it around their necks and hang themselves.

But the United States is allowed to put the rope around its neck several times, but it's coming to an end. And that's why the dollar is starting to go down, because everybody is sort of seeing it coming to an end. You just heard Mr. Stelzer put most of the blame on what's called the current account deficit. Are there any other pressures on the dollar right now? I think that's the big one. I mean, most of the time the honest truth is exchange rates move like crazy, and nobody has a clue why it's happening.

But this time I think it's different that everybody sees this borrowing cycle coming to an end, they see the federal government is driving a lot of it, the twin deficits, it isn't going into investment, it isn't building up the economic capacity of the United States.

It's just going to federal borrowing; people see it coming to an end and it was going to happen some day, and it's happening now. In the near term, Mr. Stelzer, who is winning and who is losing on such a large adjustment in the value of the dollar? Well, of course, the losers are, as Professor Rogoff said, the Americans who have nonrefundable tickets and who will find themselves in Europe on their vacations.

I think that in the long run, it's — the winners will be American companies that want to export to places like Europe, because they will have a greater advantage, the goods will be cheaper there. Exporting countries who sell stuff to us will be at a disadvantage, except for those who peg their currency to the dollar, that is who don't let their currencies rise as the dollar falls. That would be certainly China and at times Japan. So what happens in the case of China?

Professor Rogoff, they have pegged their currency to ours, and if the dollar is dropping, does that mean that the average Chinese consumer is also facing some pressures now, finding it tougher to buy things that come from other places in the world? I mean, I don't think it has such a big impact.

I think China has to let their exchange rate go. The current account deficit, this borrowing problem, is the United States' problem at heart. But Asia, China especially but also Japan, can't make Europe bear the whole burden. The euro has been soaring and the yen that's Chinese currency has been fixed. And although it really the reasons and consequences of the fall of the dollar the United States' problem at the end, we're borrowing too much, China needs to step in and share some of the burden.

Stelzer would we say, in your view, that this is a good thing or a bad thing or just something that is? Well, I think it's something that certainly is less consequential than you think from reading the newspapers.

But I think in the end right now it's a good thing for the dollar to decline in value. I think it will help reduce the trade deficit. I don't see any consequences in terms of internal inflation in America that are very major.

So we've had this before, the dollar declined 40 percent I think in — roughly the Reagan years, and I don't see any really terrible consequences from this. It's a necessary adjustment. The exchange rate is the the reasons and consequences of the fall of the dollar of dollars. There are a lot of dollars out there, so the price is the reasons and consequences of the fall of the dollar down.

Are you as comfortable with this as Irwin Stelzer? No, I think that's a very benign view. I mean, it's true during the 1980s the dollar went down a lot; Ronald Reagan got lucky, but it went down a lot during the 1970's, and that was a catastrophe, and to me there are tremendous parallels between what we see now and not the reasons and consequences of the fall of the dollar 1980's when it was relatively benign.

But the 1970's we have, we were just coming out of a strong political cycle where there was big spending, low interest rates, we have huge open-ended costs in Iraq, like we had the reasons and consequences of the fall of the dollar Vietnam in the 70's. We have unstable energy prices. So the dollar is not unwinding in a benign setting. It might be nothing. But I think it's really foolhardy to think that it definitely will be — I think it's a big risk. We've talked so far about people who travel from the United States to other countries, and American companies that export abroad.

But how will most rank and file Americans tell that something is up? Will they even recognize it? Frankly, it won't hit them this Christmas, because the prices will go up, but they won't go up right away. Importers bought things a while ago, it takes time. But next Christmas, they'll feel it.

We'll feel a little poorer. Prices will go up at Wal-Mart, prices will go up elsewhere. We're used to seeing prices go down, we'll see a period where a lot of things we buy the prices go up. Do you agree, Irwin Stelzer that we're in for a bout of inflation as a consequence of the dollar declining in value? Well, I don't think what was just described is the reasons and consequences of the fall of the dollar bout of inflation.

Prices will go up if indeed retailers can pass along the added cost, so I think you will see some prices increase. But that's what a decline in the dollar is supposed the reasons and consequences of the fall of the dollar do, that will make imports less attractive to us and it will begin to bite into the trade deficit. Those are the adjustments that should go on in markets all the time. Well, you're not saying that wages are going go up by the same amount, are you?

I mean, that's how consumers will know that something is happening to the value of the money in their pocket, no? Well, but remember that if imports become less attractive and people are buying more domestic product, you will see stronger labor markets, so again, it's quite right that there will be an effect.

But so long as the decline is gradual and we don't fall off a cliff, I don't think the effect is going to be all that noticeable. Well, is the decline going to be gradual, is there a lot more of this still to go? I think there is a lot more of it to go. I don't think it will be gradual. I think that these things tend to go in fits and starts. You'll see 10 percent here, 9 percent, you said, then you go on for a while, then you have another bout.

If everybody saw this coming gradually, it would really spike interest rates in the United States. And unless the Fed is willing to really, really raise interest rates, we're going to see these movements.

The depreciating US dollar: Causes and consequences

And we don't know what the effects will be; we don't often see a large country borrowing stuff so much. We don't often go through these big gyrations in the dollar.

And I would liken it to diving off a cliff into water, and we did it in the 1980's, it was high tide, we were okay. But it might not be next time. The financial markets, the interest rates, Europe gets hammered by this, they don't have a flexible economy.

Asia has big problems with their banks and their financial markets. It doesn't mean that definitely the reasons and consequences of the fall of the dollar be bad, but it's very risky.

It's not something I think to look at benignly. And I want to add that, yes, the dollar going down is going to help a little bit, close up these deficits but not that much.