Bellerbys Economics - Mr Stephenson

Thursday, July 12, 2007

Dollar Crisis

As predicted in our Economics lessons for quite some time now, the dollar has continued to decline and yesterday the pound broke through the £1 = $2 marker.

So, what's caused all this? Perhaps underlying the problem has been the enormous levels of consumer debt in the US over the last five years - much of this borrowing has been spent on imports creating a current account deficit well in excess of the normally acceptable level of 3% - much has also been spent on fuelling a house price boom.

For many years, the Chinese, Japanese and Germans collected dollars in payment for their exports to the US - usually in the form of bonds. However, as the underlying weakness of the US economy became more apparent, they began to try to offload these dollars onto world markets. In addition, countries are relying less on the dollar as the international currency for oil purchases.

Increased supply and decreased demand have resulted in the fall in the price of the dollar.

However, in some ways, this might just be seen as a correction - it seems likely that the dollar has been overvalued for some time and is now sinking towards its true level.

In the long term, this may be of some help to the US economy which has been struggling to compete in many industrial sectors of late and has been slipping towards protectionsim. A weaker dollar will make it easier to export after the J-Curve effect has kicked in.

You can read more about this here from the Washington Post:

http://www.washingtonpost.com/wp-dyn/content/article/2007/07/11/AR2007071101371.html

Paul Krugman, one of the world's leading economists, has a good article on the current problems here:

http://web.mit.edu/krugman/www/dollar.html

This article also looks at the problem in the wider context of the domino effect (for example, China will not want to see the dollar fall too much as it currently holds a lot of dollars in its foreign currency reserve) and also in the general area of monetisation - perhaps there's simply not enough money in the world - so many banks are holding non-performing debt worldwide that it's slowing down the velocity of money - so (gulp!) let's print a bit more!

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