With U.S. Debt Rising, Why Is the Dollar Stronger?

The standard explanations for what moves currency markets are lame. With the U.S. deficit forecast to hit $1.54 trillion in 2010 and the national debt at $12.3 trillion, why would anyone want to own the dollar? Yet somehow, the greenback has risen to an eight-month high relative to the euro. If it persists, that stronger dollar will alter the global economic and investment climate.How did the dollar get to its current valuation? Last November, it took $1.51 to buy a euro. Today the dollar is 9.3% stronger, so it takes a mere $1.37 to buy a euro. As I wrote in a 2008 article, the dollar was 92 cents to the euro when President George W. Bush took over and has lost 49% since then, so despite the recent rise, it has a long way to go to regain its former strength.

The stronger dollar creates winners and losers. The winners include Americans who travel in Europe, since their U.S. money now buys 9.3% more than it did in November. The losers are investors in commodities -- such as oil -- that are denominated in dollars (because it takes fewer of those strengthening dollars to buy a barrel of crude).

Other losers are domestic U.S. companies that sell their products in Europe: The Associated Press reports that an American automaker that wants to sell a $20,000 car abroad would have to charge 14,598 euros at today's rates, compared with 13,245 euros in November. Those higher prices will make U.S. products less competitive in Europe, while making imports to the U.S. from European and other countries with weaker currencies more attractive to U.S. consumers.

And this could cut the sales and profits of U.S. companies that depend heavily on exports to Europe or compete at home most intensely with imported goods.

Bailing Out the Eurozone's Weakest Links

These winners and losers will be affected in a serious way only if the dollar keeps getting stronger over the next several years. How can we know whether that will happen? We really can't predict the future. But one popular argument is that the dollar has grown weaker over the last decade as the U.S. government debt rose from $5 trillion to $12 trillion and as the federal budget went from a $200 billion surplus to what's now a $1.54 trillion deficit. That would argue for a continued fall in the dollar's value.

So, the recent strengthening may have to do with a more urgent issue. Worries that Greece could default on its debt, and that Spain and Portugal are also vulnerable to collapse, have undermined confidence in the euro, pushing it to its lowest level since last May and driving investors back into what they see as the world's safest currency -- the dollar.

As long as Germany and Europe's other stronger economies dither over whether to bail out the eurozone's weakest links, the dollar could keep strengthening. But if Europe decides on a plan to either expel those countries from the European Union or explicitly bail them out, the euro could regain its lost value. At that point, the U.S. could return to the decade-old strategy of using a weak dollar to prop up big U.S. companies and hedge funds.

Until the U.S. gets serious about reducing its debt and its deficits, there's no compelling long-term reason to hold the dollar. But in the meantime, it's looking like 2010 could be a good year for that trip to Europe. Too bad so many millions of unemployed Americans can't even afford to think about that.
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