March 30, 2010

Fear of falling: Why the dollar is (thankfully) destined to fall further

Posted in Macroeconomics at 11:06 am by Eamon Aghdasi

Recently I’ve heard people lamenting the weakness of the dollar, and fondly reminiscing about the good-old-days in the 1990s, when the dollar was historically strong against other currencies. I have to admit that even I wish I could go back to just a few years ago when I would drive up to visit my girlfriend (now fiancé) in Montreal, and get a huge plate of Lebanese food for about seven bucks. When your life is largely motivated by the search for cheap delicious food, the weaker dollar has made tourism a serious drag.

Within the past two years the dollar’s value has taken us for a particularly curious ride. Through much of 2008 it actually appreciated, as global investors fled to the safety of the dollar amid financial crisis (one of the few times in history, I imagine, that a country went through a financial crisis and demand for its currency actually increased). Then dating back to about 12 months ago it started a steep decline, and that’s when the exchange rate panickers came out again in full force.

When it comes to public perceptions, exchange rates constitute one of the worst-understood topics in economics. Many bright people fall into the trap of thinking “strong dollar: good; weak dollar: bad”. The simple truth is that weak can be as good or better than strong, depending on what you want or what you need . If you want to buy lots of foreign goods, then strong dollar: good. If you want to sell more of your goods and services to foreigners, then it’s actually weak dollar: good. In reality, a free market does a great job of getting you to a not-too-strong, not-too-weak equilibrium of the value of a country’s currency. (Of course, if you’re a small developing country with an inflation problem, then there are other factors at play.)

Despite the decline in the value of the dollar against most currencies over the past ten years or so, I personally believe there is still no way to go but down from here for the next ten. The rest of this blog is about explaining a) why I feel that way, and b) why this is actually a good thing.

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