Since its peak in 2002, the U.S. dollar lost nearly 24 percent on a trade-weighted basis, it declined even sharper against the euro (41.2 percent) and pound sterling (32.8 percent). Moreover, only since August, the greenback sunk 8.8 percent against the euro as the credit crisis begun to be revealed.
In the past, every time the dollar weakened, U.S. exporters and US import-competing industries were increasing their profitability. This time, despite the recent improvement in the current account, the J-curve effect” may not work as good as it did when the Plaza Accord was signed in 1985. First, it’s not likely that U.S. consumers will go away from imported goods and services since rising crude oil prices are also pushing domestic products prices higher. Second, the U.S. is not longer a closed” economy, which depends mostly on the domestic market. In fact, the import of cheap goods from developing countries helped to curb the inflation during the last few years.
So, whose problem the falling dollar is and who is suppose to deal with it? So far, the decline has caused little alarm among American politicians. Also, nothing significant was said about the influence of a weak U.S. dollar on the global economy during the last G7 meeting in Washington and the last weekend G20 summit. In one hand, the rates of return on dollar investments have declined significantly and foreign companies lost competitiveness relative to US businesses. Japan and China still hold over a trillion dollars worth of external assets in US Treasury bills and bonds. If the dollar falls further they will suffer a huge capital loss. On the other hand, this time the U.S. should take care of its currency because it is probably the country that could lose the most from a serious depreciation of the buck. The weak dollar policy could work as long as the US economy keeps growing. However, with the recession or slowdown likely to occur in the months ahead, the Fed may not be able to help the economy in order to curve the inflation pressure from energy prices. Investment spending could decline hitting the housing industry further, credit spreads rise and stocks fall.