What are the reasons for the depreciation of dollar in the current scenario?

Answer 1

The year of 2004 was the third consecutive year for the depreciation of US dollar against the Euro-dollar. When entering 2005, the exchange rate of US dollar once showed a tendency of rise, however, it was still unstable. On 30 Dec. 2005, the rate of exchange of one Euro-dollar was equivalent to 1.3623 US dollar, telling the lowest level of the US dollar against Euro in history. The US dollar began to rise to one euro against USD 1.3122 in the latter 20 days of January 2005, and kept on rising to one euro against 1.2957 US dollars in the first 15 days of February. However, the US dollar devalued sharply on Feb. 22 to one euro against 1.3260 US dollars, the lowest point since last August. It is reported that there were many reasons accountable for the depreciation of US dollars: one was that the price of oil has climbed to USD 51 per barrel; the other was the diversification for currency reserve by South Korea. People were worried that the sell of US dollar could have chain reactions upon other major powers. Different predictions could be heard on the issue of the future trend of the US dollar. According to the experts with Merrill Lynch, one of the world's leading financial management and advisory companies, the year of 2005 is the fourth consecutive year to see the weakening of the US dollars. The overvalued US dollar and the tight policy pursued by the US Federal Reserve are the due cause for the sluggish US dollar while other experts believed that the undercurrent that manipulated the depreciation of US dollar was quite likely being reversed. It's impossible to see the US dollar to drop furthermore. If the global economic growth slows down, the US dollar is hopefully to appreciate. Many reasons influence the trend of US dollar There are many factors that influence the exchange rate of US dollar. Generally speaking, there are mainly four reasons: first, the health condition and the rate of return for investment of the US economy, secondly, the balance of international payment in the US, thirdly, the level of interest rates in the US compared with those in other countries, and fourthly, the rate of inflation. Meanwhile, there are also many other temporary pounding factors from without, such as wars, oil price, scandals from large companies as well as psychological factors etc, which are believed to have connections with former four factors. Judging from the estimation by various parties, evident enough, many economists take the balance of international payments as the decisive factor for the trend of the US dollar. Although this kind of view is not unreasonable, it is partial. If considered from history, people will find out that the balance of international payment featuring trade deficit and current account deficit has been dominating the US economy since 1970s. But the track of the US dollar's circulation does not show a plummet drop. The exchange rate of US dollar used to be high for two times since the US implemented the floating exchange rate: one occurred during Reagan's reign while the other was in Clinton's rule. So far as Reagan's reign is concerned, the federal budget deficit, trade deficit and current account deficit were high, but the exchange rate of US dollar was also high. It is simply because the high deficit triggered the high interest rate and high interest rate consequently resulted in high exchange rate. The trade deficit is not the result of the change of exchange rate but rather its reason. What was worth mentioning is that the surplus was realized during Clinton's rule. But the condition of international payment hadn't been much improved due to the low private saving rate and the exchange rate of US dollar still strong. The major reason is because of the strong growth of the US economy, low returning rate and high interest rate. Therefore, should the balance of international payment exist for a long time, it would definitely be the decisive factors for the depreciation of the US dollar. But some other factors would probably counteract its function in different periods and lead the US dollar to appreciation. This tendency is believed to be likely to happen in medium or short term. Sharp drop of the US dollar exchange rate impossible Generally speaking, the sharp drop of the US dollar exchange rate is impossible unless all the US dollar holders worldwide sell US dollars in large amount simultaneously, just like depositors draw money from banks during the bank credit crisis. First, the US economy still boasts the highest growth rate and strongest competitiveness among major developed countries, and other countries are still confident about the US economy; secondly, the US dollar, serving a role of a currency for international reserve, has become the natural defense for the sharp devaluation of US dollar; thirdly, since foreigners hold a huge amount of US dollars, they will suffer severe losses if they sell dollars in large amount and will not easily find a suitable substitution. Furthermore, the safety and circulation of euro, Japanese yen and gold are no better than the US dollar. Although there is no sign of sharp drop in the exchange rate of US dollar, the possibility of gradual depreciation of it cannot be removed. In the view of Bush administration, instead of bringing harm on the growth of US economy, the orderly devaluation of US dollar can boost the exportation and narrow the trade deficit, particularly when the inflation is under control. The calculation research finding by an American economic website shows that the current account deficit is likely to drop from current six percent to three percent if the trade weighted value of US dollar drop by ten percent. The correctness of the conclusion has yet to be proved by practice. However, the economic and financial policies of Bush administration will have a vital impact on the implementation of the idea. That is to say, if the fiscal deficit continues to increase, the current account may not shrink even though the residents' saving rises again after a fall. Therefore, from a long-term point of view, the US dollars will face devaluation. However, from medium and short view, the exchange rate of US dollar tends towards stability and even a moderate rise. The best result for the current account deficit is to maintain stability or slight drop, but three percent is difficult to regain. The determination and measure taken by Bush administration to reduce the fiscal deficit will exert a tremendous influence on it. By People's Daily Online Regards Ch Asad Hanif MBA (Pakistan)