The Dollar

Recently the dollar has been falling against many major world currencies. This may be due to any number of factors, the rising deficit perhaps being the major factor. What has to be considered is the consequence of a dollar that is losing value internationally.

The primary impact is that imports get more expensive and domestic products get less expensive. So one impact would be that oil will cost more. This could be a fairly dramatic increase since demand seems to be increasing also and that would also drive the price up. However if domestic products get cheaper, more of them will be sold both here and as exports. This will lead to increased employment.

It also leads potentially to inflationary pressure. Clearly if oil increases dramatically, it will increase the cost of products to some extent, if the price increases can be passed along. Of course the ultimate determiner of prices is and always will be the supply/demand curve so price increases will not be passed along unless there is demand.

So what about demand? Clearly we have gone through a rather dramatic period in which for various reasons demand in almost all areas decreased. The most dramatic factor in the reduction of demand was simply that so much equity was lost when the real estate bubble burst that a tremendous amount of buying power vanished. Further, the resultant stock market demise further impacted wealth and demand as the majority of investors are of the buy and hold variety and they saw the values of their investments plummet. As demand weakened unemployment increased and that led to even less demand.

So we have had the stimulus payments, the bailouts and the weak dollar. But the weak dollar is an indicator of economic improvement, since it makes American products more competitive and leads to increased production. There is a tremendous amount of slack in the marketplace and the production capacity of the economy so if we see an uptick in production it will be a while before the capacity gets to levels that mean real inflation. Further, the most inefficient suppliers have been forced out of the market, so the remainder are more productive right now. The next indicator will very likely be that products start being sold at retail instead of deep discounts.

A weak dollar is at this point in our economic cycle a good indicator.