The U.S. dollar has surged as investors,
wary of the stock market’s extreme
volatility, have flocked to the relative safety of U.S. Treasuries. In some respects,
a strong dollar adversely impacts the U.S.
economy: It increases the trade deficit
while weakening exports and eroding the
competitiveness of American-made goods.
However, some entities stand to benefit
from the strengthening dollar.
“American importers, consumers buying
foreign goods, corporations making capital
investment in overseas ventures and
American vacationers traveling overseas
can all benefit from a stronger dollar,” says
Gary Loe, vice president, foreign exchange
at Comerica Bank.
Smart Business spoke with Loe about
the dollar’s rise, its implications on the
global economy and his prediction for how
the dollar will fare in 2009.
Why has the dollar strengthened against
major currencies?
This past summer, beginning with the
global credit/financial crisis, we experienced a ‘flight to quality’ effect. As equity
markets around the world have been battered, many investors sought the safety of
U.S. Treasuries to protect their money. As
investors from around the world reevaluate their risk tolerance, they buy dollars
in order to purchase U.S. Treasuries,
which are very liquid and have low default
risk, backed by the power of the U.S.
government.
The world started a global economic race
to the bottom in 2008. The world economy
has been heading toward a global recession with the U.S. in the lead. The first to
reach the bottom should be the first to
bounce back. Problems are not just contained within the U.S., as evidenced in
Germany. Europe’s largest economy is at a
15-year low in consumer confidence, and
the spillover in the credit crunch has
already reached Asia. Many believe that
the U.S. government has helped steer us
away from a deep depression. The U.S. can
act quicker to get to an eventual recovery
as opposed to Europe where many countries are needed to come together for
action.
How has the stock market’s recent volatility
affected foreign exchange?
The market has experienced extreme
volatility with a downside trend. We have
had thousand-point swings in a day in the
Dow. We have had 10 percent swings in a
day in the dollar against hard currencies
like the euro, British pound and Australian
dollar. It’s not just the U.S. stock markets
that are volatile and weak, as seen in the
S&P 500, currently down about 45 percent
this year. London’s FTSE index and Tokyo’s
Nikkei 300 index are down about the same.
The biggest effect the volatility has had in
foreign exchange is the increased bid/ask
spreads and diminished liquidity with
tighter credit standards.
Is a strong dollar good for the United States?
Usually, the word ‘strong’ is perceived as
a positive feature, but when it comes to a
country’s economy, it may not be in its best
interest. Some say a strong dollar helps
accelerate growth. Growth will attract foreign capital and boost our stock market.
This leads to increased production, consumer spending and an expanding economy. However, there are many negative
ramifications. It tends to widen the trade
deficit as we purchase more imported
goods. This increase has its detriments as it
erodes overall growth, hurts GDP and
weakens the economy. It will also hurt corporate profits of global companies as foreigners will have to pay more for U.S.
goods. The dollar should act as a self-correcting mechanism as a stronger dollar
leads to a weaker one and vice versa.
How do foreign central banks tend to react
when the dollar rises?
Central bankers in export-driven economies, such as Japan, would tend to do
nothing as it would allow growth in the
export sectors. However, if I am a central
banker where my currency is devaluing at a
pace that needs defending, I would raise my
interest rates to defend it. This should
attract flows into my currency, therefore
stopping the depreciation. Malaysia’s central bank froze its currency in the 1997
Asian financial crisis when facing steep depreciation by cutting off all market players.
Where do you see the dollar heading over the
course of 2009?
Through the beginning, we will still be
watching for weak global equity markets
and weak commodity prices and bracing
for possibly the biggest economic slowdown since World War I. As investors flee
from chancier bets and more deleveraging
takes place in the credit world, this will give
further room for boosts in the U.S. dollar.
Take advantage of any further dollar
strength at the beginning of 2009. Once our
government’s actions in stimulating the
economy and getting our credit situation
back in check take effect, look for the dollar to start weakening again, which I predict
will happen later in 2009. Fundamentals are
bound to return. At the forefront will be
renewed talk about America’s huge ‘twin
deficits,’ budget and trade. In addition, all
the printing of money that has, and will,
occur to help us out of our current financial
and economic crisis will turn inflationary,
which will erode the value of the dollar.
GARY LOE is vice president, foreign exchange at Comerica Bank. Reach him at (800) 318-9062 or [email protected].
