Dollar's slump reaches far beyond tourism

Rachel Beck
Associated Press
Sept. 25, 2007 11:05 AM

NEW YORK - The markets and Washington may be nonchalant about the tumbling dollar, but the rest of us can't afford to be.

The dollar has been declining for a while. In recent weeks, things have deteriorated, however, as the greenback has plunged to record lows against the euro and reached parity with the Canadian dollar for the first time since 1976.

There is a lot more to this story than just vacations abroad getting pricier. A plunging dollar comes with widespread economic risk, which could mean everything from higher costs for gas at the pump to mortgage rates rising.

The U.S. currency weakened sharply on the back of last week's decision by the U.S. Federal Reserve to cut its benchmark interest rate by a bigger-than-expected half point to 4.75 percent.

The central bank's rate move was intended to stem the economic fallout caused by recent financial turbulence. It ended up creating another worry by spurring investors to sell dollars as they looked to put their money into markets where interest rates are rising and economies have better growth prospects than the United States.

That has sent the dollar tumbling to new lows against the euro, which rose as high as $1.4130 on Monday to its highest level since the 13-nation euro debuted in 1999. So far this year, the dollar is down 8 percent against a weighted basket of major currencies, according to the Federal Reserve.

Even with all this going on, U.S. officials haven't talked much about the dollar's fall. Instead, they've been out in force discussing the credit-market turmoil and the housing collapse.

U.S. Treasury Secretary Henry Paulson has only rehashed the Bush administration's party line that says it wants the dollar to be strong, but isn't going to do anything about getting it there. "We believe that currency values should be set in a competitive marketplace based on underlying economic fundamentals," he said on Friday.

There are certainly reasons for the administration to like the dollar where it is right now. A weak greenback makes American goods cheaper and more competitive abroad. It also juices up the profits of U.S.-based companies doing a good portion of their business overseas.

But the dollar's steep fall also has downsides that can't be overlooked.

The Fed took a gamble by lowering interest rates when inflation was already a concern. Now that the dollar's value has collapsed even further, there are worries about increasing pricing pressures. A weak dollar raises import prices, so goods manufactured abroad and sold in the United States cost more.

The weak dollar also boosts the price of oil and other commodities that are traded internationally in dollar contracts. That is certainly clear by the record-setting move in oil prices, which have shot above $80 a barrel since the Fed cut rates and the dollar tumbled. American consumers can count on that soon showing up in higher prices at the gas pump.

The slumping dollar also makes it less attractive for foreign investors to own dollars. In recent months, they've already shown some willingness to move out of the U.S. currency, and the recent decline in the greenback threatens to exaggerate that.

Even before the recent market turmoil began, foreign buying of U.S. financial assets had slowed. A Treasury Department report showed foreign holdings of long-term securities such as equities, notes and bonds increased by a net $19.2 billion in July, the slowest pace in seven months and well below the $97.3 billion tallied in June.

Worries about foreigners wanting to diversify out of dollars rose last week after Saudi Arabia decided for the first time not to cut interest rates in lock step with the U.S. Fed, leading to some speculation that it would soon end its currency's peg to the dollar.

Also last week, an investment arm of the government of Abu Dhabi bought a 7.5 percent stake in the management operations of the Carlyle Group, a U.S. private-equity firm. In addition, the Nasdaq Stock Market announced it intended to sell a nearly 20 percent stake to Borse Dubai, and Borse Dubai and a group from Qatar also moved to become the largest stakeholders in the London Stock Exchange.

If foreigners' buying habits change, that could have a broad impact on financial markets - and U.S. consumers, too. For instance, if they sell their U.S. Treasury holdings, or don't buy new government bonds or notes, then Treasury prices will go down and yields will go up. That will likely send mortgage rates higher since they are pegged to the 10-year Treasury note.

That could unravel any good that has come from the Fed's rate-cutting action and put the economy in a precarious spot. It makes you wonder why this administration isn't doing more - or anything - to help the dollar.