Downward Dollar

RAPAPORT… The dollar has been on a steady decline as investors shun the currency due to concerns about the trade and budget deficits and general uncertainty about the U.S. economy.

The dollar is having “its weakest point in history against the Euro and the English pound,” says Evan Shelan, president and chief executive officer (CEO) of eZforex, a foreign exchange specialist. The reasons? The widening trade gap, inflation fears, soaring energy prices and the negative impact of the U.S. subprime mortgage market. In addition, says Shelan, the European economy is growing well. Shelan projects the dollar will continue to fall, with the Euro eventually rising to 1.70 against the dollar.

What’s the impact on the economy? Right now, not much. That’s because a declining dollar comes with benefits and costs. It can slow imports, because Americans using a weaker dollar will have to pay more for foreign goods. If imports cost more, U.S. consumers will buy more domestically produced goods. However, increasingly expensive imports can also contribute to inflation.

The declining dollar has certainly had an impact on import prices, according to Dean Baker, co-director of the Center for Economic Policy and Research (CEPR). Import prices have risen; nonoil imports are rising 2.5 to 3 percent a year now, after staying relatively flat, a development that could mean somewhat higher inflation in the U.S. A precipitous slide in the dollar’s value could cause serious pain to U.S. consumers because it would mean higher prices at home. “Suppose everything from China went up 30 percent,” says Baker. “People would have less money in their pockets.”

UPSIDE

But there’s a flip side. A falling dollar can increase exports, because it makes U.S. exports more attractively priced internationally. The net effect of importing less and exporting more is to correct the U.S. trade imbalance.

Short of a real recession, “That’s the only serious way to correct the trade imbalance,” says Baker.

Both U.S. imports and exports set new records in May. In July, the Commerce Department said that total May exports of $132 billion and imports of $192 billion resulted in a goods and services deficit of $60 billion, which is $1.3 billion more than the $58.7 billion deficit in April. May exports were $2.9 billion more than April exports of $129.2 billion and imports in May were $4.2 billion more than April’s $187.8 billion.

While those monthly May export and import totals were slightly higher than the three-month averages ending in May, which the Commerce Department also released, the trade deficit was slightly lower. Three-month exports of goods and services averaged $130.1 billion, while imports averaged $190.5 billion, resulting in an average trade deficit of $60.4 billion. That deficit was up slightly from the three months ending in April, when the average trade deficit was $59.6 billion, reflecting average exports of $128.1 billion and average imports of $187.7 billion.

The reason the dollar has been falling is that it couldn’t sustain such deficits, according to Baker. Foreign central banks had been buying up U.S. dollars in an effort to help their nations export goods to the U.S. “Now it’s just not worth it for them to do that,” says Baker. “Basically, they’re paying more for dollars than they’re worth.”

At a macro level, the decline of the dollar is good, because it helps the trade imbalance. But on an individual level, a weak dollar can mean fewer dollars to use on discretionary spending.

Some financial experts, however, don’t see the dollar as under serious threat. While the U.S. does have the largest trade deficit, it also enjoys the largest capital surplus in the world, attracting the vast majority of foreign funds into its fixed income and equity markets, points out an analysis by Forex Capital Markets (FXCM). The latest Treasury Inflow Capital Securities (TICS) data show a comfortable surplus of $82.3 billion against a trade deficit of approximately $60 billion. As long as TICS surpluses continue to cover U.S. trade deficits, the threat to the dollar will be more imagined than real, postulates FXCM. And diamond dealers have a similarly sanguine attitude about the impact of the falling dollar on their business.

INFLATION
Harsh Mehta, vice president of Eurostar, says his main concern would be inflationary impact. If the falling dollar causes inflation, that can limit discretionary spending. At the same time, he says, the diamonds cut in the U.S. are larger and less vulnerable to inflation.

Sruli Oster, sales manager for American Fancies, expects the falling dollar to have no impact on his company’s business. “We’re in a very special line,” he says. “We have specialty items; when someone needs what we have, the dollar does not really affect them. We have it, we service it and they’ll pay.”

Although American Fancies has competitive pricing and unique product to offer, Oster says that even diamond dealers operating in a less rarefied segment should see little impact from the falling dollar. That’s because diamond-buying patterns have changed. A few years ago, the industry bought diamonds in order to have goods in their inventory — and then found themselves pushing to sell them. “Now people are buying more selectively,” he says. “They buy what they think they have an outlet for.”

Some observers see some benefit from a falling dollar; it will make diamonds in the U.S. more attractive to international consumers. “It hasn’t affected us at all,” says Gary Schuster, Sebco International. However, he has heard speculation that the low dollar gives U.S. dealers a competitive edge because it’s cheaper to buy from them.