The Dollar's Depths, Explained
It's common knowledge that the value of the dollar is low. But why? And might it plunge any lower? Or is it poised to rally? Even though the value of the dollar affects everyday purchases for millions of Americans, these are the kinds of questions that seem pretty oblique to many consumers—and even, I can attest, to journalists who report "authoritatively" on such trends.
As part of our ongoing effort to help connect the dots in the global economy, I called Robert Hodrick, a finance professor at Columbia Business School in New York, and asked him to walk me through the various factors that determine the dollar's value. In addition to the mechanics of currency trading, I've been wondering if a weak dollar is necessarily a bad thing—and whether there's anything the United States could, or should, do about it. Some of Hodrick's answers:
How low is the dollar right now, in historical terms?
The dollar was historically high in 1984, then it weakened in the late '80s and early '90s, then strengthened again. It peaked around 2002 and has been declining since then. Right now it's pretty low, about where it was in the late '80s and early '90s.
Is it likely to get much weaker?
That's hard to say. One thing that determines expected changes is the interest-rate differential between the United States and other major countries in Europe and Asia. Our rates are slightly higher than in euro-denominated countries, with a little more of a differential with regard to the yen in Japan. But rates are pretty similar, so there isn't too much expected movement. It's likely there will be volatility of about 10 percent per year, though. So if the dollar is trading now at about $1.37 to one euro, it could easily range anywhere from $1.24 to $1.50 over the next year.
We talk about a "weak" dollar as if that's a bad thing. Is it?
It's interesting. In 1979, Michael Blumenthal, who was Jimmy Carter's treasury secretary, made a statement that suggested the United States would take a stance of "benign neglect" toward the dollar. We would let the currency market determine its value, instead of doing anything to keep it strong. That is widely viewed as having been a major mistake.
Is that because it basically said to foreigners, if you invest here, we are going to do practically nothing to protect your investment?
Pretty much. It was basically a cue to dump dollars. Every treasury secretary since then has said that a strong dollar is in America's interest, even though in general they let the market set the value of the dollar.
And the Bush administration has not really intervened to prop up the dollar, correct?
The Fed clearly watches the value of the dollar and considers that in setting interest rates, but the United States generally doesn't intervene directly in currency markets to try to change the dollar's value.
So is it true that a strong dollar is in our interest?
I think it is. It encourages investment in the United States, and it means foreign goods are less expensive to us.
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