News

If the United States were a patient, a doctor might look at the tumbling dollar like a sudden drop in blood pressure. It's a symptom of an underlying problem. Not of a heart attack or an allergic reaction, but of a binge.

For too long, Americans have been gorging on cheap credit and foreign oil, and all things that go with the lifestyle – monster homes, big cars and big-screen TVs. For 15 years, the U.S. economy has been a magnet for global products and credit.

Now the patient is overindulged; his credit card maxed out.

The dollar is falling in large part because foreigners are no longer willing to pay for all this excess. They're worried the housing meltdown and the faltering auto industry could drag the economy into recession. And this week, Ben Bernanke and the U.S. Federal Reserve injected a new concern into the mix – that cutting short-term interest rates could fuel inflation.

This is isn't a story about the Canadian dollar, which is at par for the first time in 30 years – it's all about the United States.

The greenback is tumbling against virtually every currency that isn't pegged to the dollar, including the euro, the yen and the pound.

The dollar hasn't been this low on a trade-weighted basis since the major industrialized countries abandoned the Bretton Woods regime of fixed exchange rates in 1973, said Tu Packard, an economist at Moody's Economy.com in West Chester, Pa.

“During this period of extreme turbulence, when our attention is riveted on near-term events, it's easy to miss the startling fact that since Bretton Woods ended, the U.S. dollar has never been this low,” Ms. Packard said.

Over the past five years, the dollar has lost roughly a quarter of its value against other currencies. There are worries that the United States could even cede its role as the world's reserve currency – a safe, storehouse of value for the world's central banks.

This week, Saudi Arabia opted not to match the lower U.S. interest rates, even though its currency – the riyal – has been pegged to the dollar since 1986. The move suggests the Saudis may soon abandon the peg, setting off a stampede out of the U.S. dollar by oil-rich Gulf states, according to some analysts.

Two of Saudi Arabia's neighbours, the United Arab Emirates and Kuwait, have already said they want to cut their U.S. dollar reserves. And in May, Kuwait ended its own peg to the U.S. dollar. The UAE may be next.

“Because the oil-rich nations are paid in an increasingly falling U.S. dollar, their purchasing power diminishes and their imported inflation surges,” explained Ashraf Laidi, chief foreign exchange analyst at CMC Markets in New York. “Economic realities are making the current arrangement increasingly untenable.”

There is an estimated $3.5-trillion (U.S.) of Arab money parked in U.S. dollars. If Saudis and their neighbours decide they no longer need to hold U.S. dollars (or price their oil in dollars), the greenback's decline could become a rout.

The lower dollar is, of course, a boon for U.S. exporters. Chemicals and biotech giant E. I. du Pont de Nemours & Co., for example, which generates 60 per cent of its sales outside the United States, is enjoying windfall gains at a time when the recession in housing and autos is hurting its domestic business. In its most recent quarter, the falling dollar alone accounted for half of the company's 6-per-cent sales increase.

“From a U.S. dollar standpoint, it's been a net-net benefit to us over recent quarters,” acknowledged Jeff Keefer, du Pont's chief financial officer.

But it's not like the company is about to restructure its business to capitalize on the falling dollar. “The predominance of our strategy is really around our customers and customer needs – to go where the growth is,” he said. “We look at [the dollar], but it's not a determining factor in where we put our resources for growth.”

In an ideal world, a lower dollar should eventually ease the U.S. trade deficit, as well as the broader current account gap (which also includes financial flows). Thanks to foreign sales by companies such as du Pont, both deficits have retreated a little from record levels in recent months. But at more than 5 per cent of gross domestic product, the trade and current account deficits remain exceptionally high by historical standards.

There was a day when exchange rates alone might ease these imbalances, which can result in too much consumption or credit in one region.

On this day 22 years ago, finance ministers and central bankers from the major industrialized countries met at the Plaza Hotel in New York to restructure the global economy. The centrepiece was an agreement to inflate the value of major currencies against the dollar.

Even if Washington wanted to orchestrate a similar scheme today, it likely wouldn't pack the same punch. China's yuan is pegged to the U.S. dollar and oil, now selling for more than $81 a barrel, is priced in U.S. dollars. Together, China and oil account for roughly 80 per cent of the U.S. trade deficit.

So unless the price of oil falls substantially or China moves quickly to revalue the yuan, the trade deficit is fated to remain high – even as the dollar falls.