Dollar Lows against Euros

Today CBS News reports that the dollar/euro exchange rate has burst through the 1.32 level for the first time. This is big news for people that are traveling to Europe and seek to buy things there. Everything in Europe seems to be getting more and more expensive for dollar-based purchasers. Just a few short years ago I remember when .87 dollars was equivalent to a euro – and things in Europe then seemed cheap to me. But that is not the case anymore.

Many of us are asking why the dollar sinking to such a low value against these foreign currencies. What makes the dollar seem to have such a low value to the rest of the world?
The answer is quite surprising. The U.S. economic numbers that came out just before Thanksgiving were not the reason for the plunge (see this Reuters article). Although these numbers were positive / mixed – the real reason most are citing for the plunging dollar is our soaring current accounts deficit (see this from the BBC). In short, the U.S. is importing more than we export.

By importing more than we export, the U.S. is sending dollars into circulation around the globe. We pay for our imports in dollars – and these dollars end up in foreign economies. But, since consumers in these foreign economies do not use dollars for their day-to-day purchases, these dollars don’t have the same usefulness to them as their own currency.

Because the U.S. economy is so strong right now, our consumers’ level of demand is very high. We like to purchase foreign goods, and so even as the dollar loses its value against these foreign currencies, and even as these foreign goods become more and more expensive to us (in a relative sense) – we keep on purchasing them.

Normally, these dollars would circulate back to the U.S. as foreigners used them to purchase goods from us. As they import U.S. goods, these dollar flows would have a productive use for them.

However, the other economies of the world (Europe in particular) are not nearly as strong and robust as ours. Consequently, their consumers have less disposable income with which to purchase foreign goods. What little they have goes to purchase bread and potatoes (figuratively), all of which are purchased with their own currency, not U.S. dollars. Add to this the unfavorable tariffs that many of the countries have placed on U.S. goods – making them even more expensive, and it is easy to see why these economies are not importing from us. They have more pressing, domestic expenditures to make.

Their weak economies and their tariff structures mean that their spending focus is in their own markets – and tend to be in their own currencies. As we flood their markets with our dollars – their consumers have little use for them – and so they begin to accumulate... These dollars are not as useful to them as their own currency is. So, what dollars they do accumulate, they tend to trade for a pittance in their own currency – just so that they can purchase the basics that they need (so to speak).

Add to this the global turmoil of late. The dollar has become a safe haven in times of global unrest. Consequently, more and more of the U.S. debt is purchased by foreigners seeking safe investment harbors. This flow of cash into our economy adds to our money supply – heating up our economy even more. And, at the same time, more and more of our country’s interest payments are being made to foreigners – adding even more to the flood of dollars flowing out beyond our borders.

In order for the dollar to become stronger, the global economies (and especially the European economies) need to see more growth. And specifically growth that leads them to be able to afford the “exotic” products and services being offer by U.S. producers. Growth for the Europeans can only come if they make some structural changes – change their tax regimes, change their labor and business policies. And these changes will be slow.

Further complicating the process is the fact that our U.S. economy is experiencing huge surges in productivity – especially in the service sector. (See this):

Studies by the McKinsey Global Institute of selected service sector industries suggest that labor productivity in the United States is greater than in France, Germany, Japan, and the United Kingdom by 30 percent in the airline industry, 30 to 40 percent in retail banking, 20 to 50 percent in telecommunications, and 10 to 50 percent in retail selling. In part because the U.S. domestic market for services is so well developed, the United States is the world's leading exporter of business and professional services. The service sector overall contributed a positive $76 billion to net trade in 1999, whereas goods trade was in deficit by about $345 billion.

It is the more mature economies that purchase these sophisticated business and professional services from the U.S.

The share of services in U.S. exports should increase further as the United States' trading partners grow and mature. For example, services account for about 35 percent of U.S. exports to the mature economies of Europe, where the share of services in GDP is about 70 percent; 25 percent of U.S. exports to South and Central America, where the service share of GDP is about 57 percent; but only 18 percent of U.S. exports to China and India, where the service share of GDP is 37 percent.

We buy basic goods from the world – because they are cheap and desirable to us, and the world is buying complex services from us, because we are simply good at providing them. This means that mature and strong economies are some of the best candidates for our best exports (i.e., these services). We buy from poor countries, but only the developed buy from us. These are difficult trends to turn around.

If we want a stronger dollar, then we need to ensure that these other economies grow and hope that they change structurally to allow their consumers to purchase goods (and services) from the U.S. Global peace would help too. But for now, let us look to help Europe's stagnating economies get out of the doldrums.