A weakening dollar could be good news for the American, European and world economies all at once. But this will only be true if the dollar’s decline is gradual and moderate, and this cannot be guaranteed. A sharp fall could spell trouble
"CURRENCY forecasters who have long predicted its decline have seen the dollar climb inexorably for years. At last it seems to be turning. Since February the dollar has fallen by 9% against the euro, to a 17-month low of $0.94. It has also hit a six-month low against the yen, of ¥123. It may well fall further over the coming year."
"Two factors weigh against the dollar. First, it is by most yardsticks overvalued. Its trade- weighted level, adjusted for inflation differentials, remains well above its average over the past couple of decades. And second, America’s large current-account deficit, at more than 4% of GDP and growing, looks unsustainable. If the dollar stays roughly where it is as the economy rebounds, then the deficit will grow. As a rule, once a country’s external deficit approaches 5% of GDP, its currency tends to fall."
"To trigger a slide, foreign investors do not have to become net sellers of American assets. The dollar will fall if they merely reduce the pace at which they add to their holdings. It will fall even more if American investors continue or expand this year’s buying of foreign assets, notably European equities."
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