By Hans Wagner
One of the most important global economic trends is the U.S. dollar devaluation. In this article on global economic trends, we are addressing three of the important fundamental factors encouraging U.S. dollar devaluation.
The devaluation of the U.S. dollar vs. other currencies depends on a number of factors, primarily relative interest rates and inflation of each country, the level of deficit spending by governments, and the demand and prices for imports and exports.
Economists have assumed that higher interest rates will lead to an appreciation in the currency. On the demand side, they assume that higher interest rates will attract foreign capital that increases the demand for the local currency. On the supply side, higher interest rates tend to reduce domestic consumption, reducing the demand for imports that lowers the supply of currency leading to a higher value. Unfortunately, this simple view does not always work out as expected.
Presently in the
When investors look at the inflation rate for a country,
they must consider the current rate as well as the future rate. After all, they
want to be sure to account for any changes in the rate of inflation, as it will
affect their investment. If inflation is more likely to rise in the next several
years, then investors will look for higher interest rates to protect their
investment. If longer-term rates do not adequately cover their inflation
expectations plus a return on their money, capital is likely to flow out of the
country, forcing currency rates to fall. Since the Federal Reserve is working
hard to keep interest rates low, it is by default encouraging those investors
who fear inflation in the future to move their capital out of the
Another important factor in the value of a currency is the status of the trade balance. Countries that have a positive trade balance where exports exceed imports, see capital flow into their economy. This capital inflow encourages the value of the currency to rise, raising the cost of exports, and lowering the cost of imports. In theory if all other things are equal, this will tend to stabilize the trade balance.
For countries that experience a trade deficit, like the
When the prices of oil, copper, gold and other commodities rise, they tend to take with them the currency of the country exporting the material. As demand for commodities, increases it tends to raise the value of currencies of commodity-producing countries. Rising prices of commodities help the commodity-rich nations to experience falling trade deficits and might even lead to positive trade accounts, as long as they manage their imports. Currencies of commodity exporters fall when commodity prices fall. The reverse holds for commodity importers.
A negative trade balance encourages U.S. dollar devaluation as capital flows out of the country. As long as the U.S. imports more than it exports, the negative trade balance will compel the U.S. dollar devaluation.
As a global economic trend, the U.S. dollar devaluation is a balancing mechanism that tries to offset negative fundamental factors. The U.S. dollar is reflecting the negative consequences of low interest rates relative to the potential for inflation, serious government spending deficits and a large trade deficit. Each on their own put downward pressure on the dollar. All three together will encourage the dollar devaluation. The fundamentals of the dollar will force it to fall further despite what the politicians say.
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