When Will the Dollar's Decline End

hen Will the Dollar's Decline End?
By [http://ezinearticles.com/?expert=Richard_Pettinger]Richard Pettinger

The dollar has been falling for several years. The weakness of the dollar threatens to undermine the American economy and the global economy. To predict the future trend of the dollar we need to understand why the dollar is falling in the first place. Many of these factors are still in place and explain why the dollar may continue to fall.

Why Dollar is Dropping

1. Large Current Account Deficit.

A large current account deficit means that imports of goods and services are greater than the value of exports. A deficit doesn't mean that a currency has to devalue. However, the problem is that the US current account deficit is over 5% of GDP and now the US is struggling to attract sufficient capital flows to pay for the current account deficit. With capital inflows drying up it means the currency is likely to fall.

2. Low Interest Rates

The Fed is responding to the slow down in the economy by cutting interest rates. As interest rates fall it is less attractive for foreign investors to buy US securities and save in the US. Therefore, there is less hot money flows coming into the US. This is quite significant because recently the US interest rates became lower than the interest rates in China. It meant that there is less incentive for the Chinese to use their surplus foreign exchange to buy dollar assets.

3. Nobody wants the Dollar any more

Who wants to buy a currency that has lost 30% of its value. Asian investors are realising that they are better off diversifying out of the dollar (the Euro has seen more stable and more attractive). The consequence is that confidence in the dollar's prospects are declining and therefore people are buying less and looking to sell.

4. Housing Crisis

Related to the sub prime crisis less people are looking to buy a house in the US. Many existing homeowners are facing repossessions and all these factors combined is causing house prices to fall. Falling house prices have a very negative effect on the economy. When house prices fall people feel worse off and so spend less. The problems in the housing market are very likely to cause a recession. Whilst house prices fall there will be tremendous pressure on the Fed to cut interest rates. Lower interest rates is the best chance of avoiding recession. But, if US interest rates do fall to 1% as some people predict it will cause a further devaluation in the exchange rate.

View more: [http://www.economicshelp.org/blog/predictions/exchange-rate-predictions/]Exchange Rate Predictions at Economics Help.org

Richard Pettinger studied Politics and Economics at Lady Margaret Hall, Oxford University. He now works as an economics teacher in Oxford. He enjoys writing essays on Economic and he edits a site - Economic Help. http://www.economicshelp.org/

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