Accessibility links

Breaking News

U.S.: As Economy Recovers, Dollar's Drop Seems To Defy Logic

The dollar's dive against the euro on currency markets has analysts puzzled. While the U.S. economy shows strong signs of recovery, the European Union's eurozone is relatively flat. Yet the dollar remains in free fall, touching a record low against the European common currency just this week. Traders say it could fall still further. RFE/RL asked analysts what could be going wrong for the United States or, indeed, right for Europe?

Prague, 4 December 2003 (RFE/RL) -- The U.S. dollar's steep decline on international currency markets seems illogical, if one looks at the latest economic statistics.

Judging by the numbers, the U.S. economy is soaring. U.S. gross domestic product (GDP) -- the total size of the economy -- surged some 8 percent in the third quarter of this year (July-September), the latest statistics available. Worker productivity during the period rose at an annual rate of about 10 percent -- the biggest rise in 20 years.

By contrast, the European Union's eurozone looks almost dead. Germany and several other eurozone economies are teetering on the edge of recession, and 2004 is not expected to bring dynamic growth.

Normally, such stunning numbers from the United States could be expected to stimulate international demand for dollars as investors around the world are attracted to the relatively higher returns offered in the United States. This would propel the U.S. currency higher.

But the opposite is happening. The U.S. currency has fallen 15 percent in 2003 against the euro, and just this week -- despite the good U.S. economic news -- it touched a new all-time low against the euro.

Vincent Koen, a senior economist at the Paris-based Organization for Economic Cooperation and Development (OECD), says currency movements are difficult to understand and often follow no apparent logic. Nevertheless, he says the dollar appears to be caught in a trap of negative sentiment -- much like the euro was a few years ago.

"We are now in a situation -- [it is in fact] the converse of the situation three or four years ago, when the euro was suffering. The euro would then be hurt -- [it would] depreciate -- every time there was a piece of bad news in the euro area. Good news in the euro area would only suffice to keep the euro steady, but not bring it back up. There was an asymmetry there. Now, it's the reverse. Good news on the U.S. front [seems only to keep the dollar steady, while any piece of bad] news seems to be an excuse to put it down," Koen said.

To be sure, the recent U.S. GDP numbers do not tell the whole story. There are several good reasons to explain why currency traders -- and the general public -- may now be afraid of holding too many dollars.

The U.S. government in recent months has run up a huge budget deficit, due mainly to the rising costs of the Iraq war and the war on terrorism, and a series of tax cuts. The U.S. trade deficit -- called the current-account deficit -- is also rising, as Americans continue to import more and more goods from abroad.

These twin deficits are unsustainable in the long term, leading many to believe a larger dollar depreciation is coming.

Another reason for the dollar fall is interest rates. The U.S. central bank, the Federal Reserve, has slashed rates to 40-year lows -- to around 1 percent -- to stimulate borrowing and economic growth. The European Central Bank, too, has cut rates, but not by as much. Euro savings accounts and bonds these days simply offer better returns.

The chief analyst of the German-based Bremer Landesbank, Folker Hellmeyer, was quoted this week by dpa as saying the "failure of U.S. foreign, trade, economic, and fiscal policies had combined to form a poisonous cocktail to weaken the dollar." He described Washington's budget policies as "out of control."

Others agree, but are not so dire in their predictions. They say it is only a matter of time before traders catch on that the U.S. recovery is genuine. In addition, they say, as the U.S. recovery gains momentum, the U.S. Federal Reserve will have to raise interest rates. This, in turn, will support the dollar.

Koen says the real danger is if the dollar's fall accelerates, resulting in very large trade and investment imbalances. "What we fear is an abrupt dollar depreciation. If it's gradual and largely anticipated and not too big, then I think it can be absorbed," he said. "But if it's sudden -- sudden and big, of course -- then it can hurt a lot."

He says a managed long-term drop in the dollar -- similar to what happened in the second half of the 1980s -- could easily be absorbed by the world economy, but might end up making Americans feel poorer when they travel abroad.
  • 16x9 Image

    Mark Baker

    Mark Baker is a freelance journalist and travel writer based in Prague. He has written guidebooks and articles for Lonely Planet, Frommer’s, and Fodor’s, and his articles have also appeared in National Geographic Traveler and The Wall Street Journal, among other publications.