What Happens When the Dollar Falls?

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What Happens When the Dollar Falls?
What Happens When the Dollar Falls? (Image: U.S. Treasury / Wikipedia Commons, British Museum / Wikipedia Commons, Diliff / Wikipedia Commons)

Benchmark for National Success

Currency values are used as a benchmark, or measuring standard, for national success. Excessive money supply against weak demand and a general lack of confidence pertaining to the country's welfare adversely affect valuations of the U.S. dollar. A weak dollar impacts international trade, inflation and the U.S. political climate at various levels.

Increased Supply

Basic economics articulates that the increased supply of any asset leads to falling prices, as competing buyers need less money to access the market. Falling dollar values are the consequence of additional supply. The Treasury maintains the power to tax, or simply "create" money by printing more of it. The Federal Reserve Board (Fed) manages interest rate policy through open-market purchases of government debt. The Fed actually keeps interest rates low by injecting fresh dollars into the financial system with these transactions.

Traders monitor U.S. deficits, or official money that is owed to international governments and domestic government spending. The value of the dollar falls when people realize that the Federal Government must again create money to make good on high amounts of debt, or even default, which would be catastrophic. Argentine, Mexican and Russian debt defaults set off panic and led to the collapse of pesos and rubles.

Inflation

Devalued currency leads to inflation, or elevated price levels. Purchasing power falls because more dollars are required to compensate the sellers of goods for their wares. In particular, a weak dollar leads to higher prices for commodities and imports. According to Steve H. Hanke, professor of applied economics at the Johns Hopkins University, declining dollars were responsible for 51 percent of oil price appreciation during the 2003-2008 oil boom.

International Trade Patterns Shift

A weak dollar provides support to the U.S. export economy. Corporations that transact international business and merchants that sell goods overseas are able to effectively undersell competitors. The costs of domestic production, priced in weak dollars, are relatively cheap in relation to foreign exchange. Additionally, exporters are paid in valuable foreign currency, which translates into increased profits and purchasing power when converted into U.S. dollars.

Meanwhile, foreign exporters will have difficulty selling their goods in the U.S. marketplace when the dollar falls in value. Foreign goods become expensive because retailers must earn more dollars as adequate compensation for the lost purchasing power.

Weak dollars affect foreign exchange and international business.
Weak dollars affect foreign exchange and international business.

Confidence Falls

U.S. consumer confidence pushes Americans and foreigners to purchase goods, hire employees and invest within the stock market. These activities increase the valuations, and therefore the demand, for dollars. Conversely, the lack of confidence causes business activity to stall and lessens the demand for dollars. The price of any asset falls when demand is weak.

Confidence carries a bilateral cause-and-effect relationship, in regards to the value of the U.S. dollar. A general lack of confidence in the ability of the U.S. economy and political establishment to increase gross domestic product (GDP) and pay down debt causes the dollar to fall. A weak dollar serves as confirmation that the nation is in poor standing; confidence then deteriorates even further.

Political Fallout and Reforms

Americans pressure politicians when a weak dollar leads to high levels of inflation and a general lack of confidence. Unrest often leads to reforms that support the dollar and a reversal of current policy; deficits are paid down and interest rates are raised to effectively take dollars out of circulation.

A weak dollar may have political fallout.
A weak dollar may have political fallout.

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