The dollar’s decline is overdone
The pound is strong against the dollar and weak against the euro. Something is wrong and it is the dollar.
While Britain historically measures the strength of its currency against the US currency, our trade is with our European neighbours so we are net losers from this foreign exchange imbalance but it is one that will surely start to turn.
The weak dollar reflects the weak US economy. America certainly is in trouble, but while things there are bad, they are not disastrous. Certainly not by the standards of past recessions. And while European economies are stronger, they are rapidly slowing down.
The exchange rate should thus not be comparing terrible US prospects with a perfect European outlook but balancing two deteriorating economies. On that basis, the dollar is oversold and the euro overvalued.
But while transatlantic trade is modest compared with business within the two continents, much European trade is denominated in dollars. In particular, the weak US currency has protected Europe from the full effects of the rising price of oil. That cushion will end when the dollar regains its strength.
It will please certain governments, however, principally China, that have funded the US balance of payments deficit by investing the proceeds of their export sales back in a dollar that has steadily devalued.
If the US authorities seem to be showing little concern at their undervalued currency that may be because of the long political impasse ahead of November’s election but the fear of imported inflation may bring the exchange rate onto the domestic agenda. The interest rate cuts aimed at boosting the US economy have weakened the dollar’s international value.
For Europe, the euro makes exchange rates an irrelevancy for trade within the zone but Britain is caught as the fulcrum of this currency seesaw. The strength against the dollar is of limited value to us while the pound’s weakness against the euro is making imports more expensive. When the re-alignment comes, Britain will benefit from a decline in the dollar only if it is accompanied by the pound strengthening against the euro.
