The Effects of a Falling US Dollar on the Economy of the United States

us dollar and the effects on the economy - usa vs chinaMany people tend to shrug off news reports that talk about the plunging US dollar. "A rising or falling dollar doesn't really effect me, so why should I care?" The fact of the matter is that a dropping or rising US dollar affects every man, woman and child in the country, and a continued weak dollar has significant consequences on the economy.

The first question that you might have is: what would cause the US dollar to drop so rapidly over the past 6-7 years?

There are many reasons why the US dollar has dropped, but here are the top three:

1. The United States has a very large import/export imbalance. The United States imports much more than it exports. A country like China on the other hand, exports MUCH more than it imports. This is important. China will build up massive amounts of US dollars and US debt in its reserves, and will eventually sell dollars and buy other things (Euros, oil, gold) in order to diversify.

2. Spiraling debt and large deficits. Big deficits translate into increased amounts of debt for the country. One of the biggest reasons for the large recent deficits is the "war on terror." It costs tremendous amounts of money to maintain the USA's military presence, especially in Iraq and Afghanistan, and this all translates to a large yearly deficit, which becomes debt. A country has a balance sheet just like a business does, and their currency is a proxy that tells you how well the country's "books" are looking. If a country such as the USA has ballooning debt and deficits every year, their dollars will be sold in favor of something else, such as the Euro.

3. Other factors will conspire to weaken the US currency against others in the world, such as spiking oil prices and a declining housing market. The subprime mortgage meltdown in the United States and the spiking prices of oil have resulted in a weaker US currency. Let's take a country like Canada. Canada is resource-rich and due to the high oil prices will have a much stronger "balance sheet" every year due to those extra revenues. The United States, for the most part, must import their oil. These things all conspire to create not only a weak US currency, but also strong currencies throughout the world.

Now - what is the impact of a falling currency on you, a normal citizen? Someone who may make 50k a year? Someone with a mortgage and a car payment?

Well first off, a falling US dollar means that it costs more to import goods from other countries. The US dollar won't go as far, so it costs companies more to purchase goods throughout the world. They in turn will undoubtedly pass those increase costs on to you. So that imported vehicle, fresh BC salmon or bed will cost more money to import, meaning more money out of your pocket book when you go to buy them.

Some people would argue that this is a good thing, as it would cause the US to become more self-reliant and force them to produce their own goods, meaning more jobs for US residents. This might be true, however:

1. Many US companies outsource many components of their manufacturing and development anyways and couldn't afford to run their operation solely in the United States

2. Many people are accustomed to certain namebrands and won't considering buying anything else.

Now, what happens if prices rise in general? This means inflation. What happens when we have inflation? Interest rates go up in an effort to keep inflation in check by decreasing the supply of money. By decreasing the supply of money in the economy, you keep prices in check. For instance, if the US government suddenly decided to print off $100 trillion dollars in new bills, the price of goods and services would leap as well.

Increased interest rates mean higher borrowing costs. Increased mortgage payments and increased car payments.

Also, a weakened US dollar means that companies in the United States are much cheaper to purchase for international buyers. We have seen quite a bit of this recently; large funds, operated by countries such as China or Saudi Arabia, are using their riches to purchase American companies or at least large stakes in them. It can be pretty hard for a company to say no to billions of dollars in equity investment if a country like Dubai comes along and says "Here is $4 billion in cash for 33% of your company."

chinese president wearing a boeing capFor a country like the United States which is helplessly dependent on imports to get by, a weak US dollar has a major impact by making these purchases more expensive. This leads to less buying power for the American consumer and increased foreign ownership in American companies. Interest rates go up to combat inflation, and borrowing costs increase. Some countries will turn inwards and become self-reliant during a period of weakness in their currency, but American doesn't really have the capability or infrastructure to do that. As a society we are so reliant on other countries that we really have no choice but to pay the extra costs that come as a result of a weak currency.

For anyone who ever worries about China becoming a superpower, consider this fact: China has literally hundreds of billions of dollars in US dollars and debt being held in their forex reserves; what would happen if they just decided to sell all of their US dollars one day just to spite the United States? For this reason, China will always have a sword dangling over the head of the United States, and would use that as a weapon if hostilities ever escalated between the two countries, I can guarantee it.

Filed under: The Economic Meltdown | Stock Market Education | General Knowledge

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