Dollar Depreciation Economic Effects of Term Paper
- Length: 11 pages
- Sources: 5
- Subject: Economics
- Type: Term Paper
- Paper: #80386088
Excerpt from Term Paper :
However, if one expands their outlook to a global perspective, the is only a correction and will help to strengthen the position of other currencies. As the U.S. dollar grows weaker, other currencies grow stronger. The depreciating dollar may cause Americans to alter their lifestyle, however, from a global perspective; the situation is not that dire.
One of the key concerns for investors has been what will happen to commodity futures. According to Abacus Consulting Services and Los Angeles Chinese Learning Center (2005), commodities will be bullish. Commodity prices will increase as the U.S. dollar decreases. However, there was little to support this opinion. Their opinion is based on past trends that indicate that commodity prices are inversely proportional to whether the U.S. economy is in an inflationary or deflationary mode. They point out that during the Great Depression, commodity prices doubles from 1932 to 1934.
Factors that Could Affect the Outcome
Many factors could help to offset the effects of U.S. dollar depreciation including the policies that the Federal Reserve Board decides to adopt in response. It is likely that the Federal Reserve will take measures to correct the situation before a complete disaster results from the continuing trends. Rising oil prices and other energy prices will also be a factor in whether the current trend continues (Abacus Consulting Services & (Los Angeles Chinese Learning Center, 2005).
It is the consensus among analysts that that the depreciating U.S. dollar will close the trade deficit and restabilize the trade balance. Many of these opinions are based on monetary theory and on historical trends. However, some disagree with this analysis. Goldberg & Dillon, (2007) feel that there are several factors that could damper the effects of dollar depreciation to the point where the impact on import prices would be minimized. According to this analysis, the use of the dollar in invoicing U.S. trade, market share concerns of exporters, and rising U.S. distribution costs will offset the positive effects of the depreciating dollar on the trade deficit.
This analysis concludes that dollar depreciation will have little impact on reducing the current trade deficit. As U.S. goods become more attractively priced overseas, it will have a theoretical increase in demand for U.S. goods. However, there are many factors, including rising transportation costs that will force prices to remain high. This will dramatically reduce the effects of dollar depreciation. Goldberg & Dillon (2007) feel that the effects will not change the overall picture significantly. U.S. prices for exports will still remain high due to rising costs. However, the depreciating dollar will help to offset these price increases, perhaps slowing the trade deficit increase to some degree.
The price of gold can give us important clues about the economy and its future direction. This important indicator is often ignored by economists, but it can act as a thermometer by which to measure the overall mood of the consumer. Between 1980 and 200 the price of gold fluctuated little. Therefore, it was of little economic interest. However, since 2001, the price has demonstrated a steady rise, peaking at over $600 per ounce (Paul, 2006). This price rise is not significant in itself. The mechanism that causes gold to rise is of interest in our discussion of the depreciation of the U.S. dollar.
As the value of the U.S. dollar declines, the price of gold rises in proportion (Paul, 2006). A gold standard is an assurance that paper currency has some "sound" form of value. Recently, Alan Greenspan preached that if managed properly, paper money would have the same "sound" attributes as gold. The gold standard represented a rigid discipline in monetary policy. This standard is much freer when currency is the standard (Paul, 2006). To put this in perspective, consider that in 1934 a dollar was worth 1/20th of an ounce of gold. In other words, $20 would buy an ounce of gold. However, in 2006, a dollar was worth 1/600th of an ounce of gold. It would take $600 dollars to buy one ounce of gold.
The same types of rises have been seen when one compares almost any other staple commodity over the same time period. However, gold gives us a tool to measure the depreciation of the U.S. dollar. When one examines rising gold prices as a reflection of he depreciation of the U.S. dollar, it appears to be an alarming situation. For the average American, if their money will buy less gold, it will also buy less of other commodities as well. They now feel that they have to work harder in order to afford the same lifestyle that they enjoyed for less several years ago. Americans do not make it a habit to check gold prices, but they do feel the pinch in the average cost of living. Gold simply provides a set commodity quantity against which to measure the decline of the dollar.
Foreign policy is another factor that plays a significant role in the economy and the value of the dollar. The American public would never tolerate direct tax increases to fund a foreign war under the gold standard (Paul, 2006). However, with the ability to create currency at will, the real costs of war can be hidden from the people to curb their resistance to the war from a financial standpoint (Paul, 2006). Paul argues that although the U.S. public does not directly see the effects of the war on their lifestyle, war still has an effect by boosting spending. This increases the national debt, leading to inflation. However, because these effects are indirect, the average citizen does not attribute the source of their woes to the war.
Paul argues that the price of gold has not risen, the value of the dollar has fallen. This is an interesting slant on our understanding of gold prices. According to this analysis, one could estimate that the value of the dollar has fallen by 60% (Paul, 2006). However, one must ask if this analysis is a narrow approach to a much larger picture. According to Nielson (2007) the decline in the dollar has only mounted to 13% in the same time period. These two numbers apparently considered different factors in their calculations. Differences in calculations account for many of the differences in opinions regarding the future outcome of the current bearish trend in the dollar.
Nielson (2007) agrees that a weakening dollar has helped to offset the trade deficit and that it has been a blessing in disguise. In May of 2007 exports reached an all-time high of $132 billion (Nielson, 2007). This demonstrates that foreign demand for U.S. products has responded to the price adjustments created by a devalued dollar. As the dollar weakens, demand for U.S. goods increases both domestically and abroad. The trade deficit is decreasing, which should free up funds to help pay back some of the national debt, at least if politicians decide to spend it in that manner.
From the standpoint of increased demand for goods, it can be argued that the depreciation of the dollar is actually good for the economy. However, when one considers the increase in commodity prices, it would appear to put a pinch on the wallets of the average American citizen. Rivens, (2004) indicated that the current trade deficit was nearly 5% of the economy, using this as a basis for a gloomy outlook. However, this is actually a decrease from the record 7% in 2005, which was not mentioned. Increases in demands for U.S. products were a key factor in the ability to reduce the debt. Extra funds were used to offset the debt. Therefore, the 5% reported by Rivens was an improvement of the past several years.
This research has examined the key sides of the arguments regarding the depreciation of the U.S. dollar. There is little disagreement that the trade deficit is a result of trade imbalances and the need to finance import invoices. However, when one examines the outlook for the future and the effects on the U.S. And global economies, one can find a wide variety of opinions. One of the most disturbing aspects of this analysis was the ability to ignore facts that did not support the opinions of the analysts, such as the failure to mention a decline in debt by Rivens (2004). Citing that the debt represents 5% of the economy would point to a gloomy outlook. However, when one places it in perspective, it represents a downtrend in debt, rather than an increase. If the reduction in debt continues to decline, future prospects will look much brighter.
It would at first appear that the current dollar depreciation is bad for the American economy. However, when one examines expenditures vs. dollar depreciation over the past several years, it would appear that the depreciation of the dollar may have been the redeeming feature that kept the economy from declining further. Lower priced goods, meant the ability to…