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Weak Dollar What it Means How it Works

Weak Dollar What it Means How it Works

Weak Dollar: What it Means, How it Works

What is a Weak Dollar?

A weak dollar refers to a downward price trend in the value of the U.S. dollar relative to other foreign currencies. The most commonly compared currency is the Euro, so if the Euro is rising in price compared to the dollar, the dollar is said to be weakening. Essentially, a weak dollar means that a U.S. dollar can be exchanged for smaller amounts of foreign currency. This makes goods priced in U.S. dollars, as well as goods produced in non-U.S. countries, more expensive for U.S. consumers.

Key Takeaways

  • A weak dollar means that the U.S. dollar’s value is declining compared to other currencies, particularly the euro.
  • A weak currency has both positive and negative consequences.
  • The Fed usually employs monetary policy to weaken the dollar during economic struggles.
  • Policy makers and business leaders have no consensus on whether a stronger or weaker currency is better for the U.S.

Understanding What a Weak Dollar Means

A weakening dollar has several consequences, not all of them negative. It makes imports more expensive but also makes exports more attractive to consumers in other countries. Conversely, a strengthening dollar is bad for exports but good for imports. Despite traditionally favoring a strong currency, most developed nations have pursued policies favoring weaker currencies since the 2008 financial crisis. A weaker dollar, for example, allows U.S. factories to remain competitive and can stimulate the U.S. economy. However, several factors, not just economic fundamentals like GDP or trade deficits, can lead to a period of U.S. dollar weakness.

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A sustained period of time is necessary to describe a weak dollar, not just a few days of price fluctuation. Similar to the economy, the strength of a country’s currency cycles, resulting in extended periods of strength and weakness. These periods can occur due to factors unrelated to domestic affairs, such as geopolitical events, weather crises, financial strain, or population trends over the course of years or decades.

The Federal Reserve works to neutralize these influences through monetary policy. During a period of tight monetary policy, when the Fed raises interest rates, the U.S. dollar is likely to strengthen. Higher interest payments on the currency attract investment from global sources, temporarily boosting the U.S. dollar. Conversely, a weak dollar occurs when the Fed lowers interest rates as part of an easing monetary policy.

Quantitative Easing

In response to the Great Recession, the Fed employed several quantitative easing programs, purchasing large sums of Treasuries and mortgage-backed securities. This move caused the bond market to rally, pushing U.S. interest rates to record lows. As interest rates fell, the U.S. dollar substantially weakened. From mid-2009 to mid-2011, the U.S. dollar index (USDX) fell by 17 percent.

Four years later, as the Fed began raising interest rates for the first time in eight years, the dollar’s fortunes turned, and it strengthened to reach a decade-long high. In December 2016, when the Fed shifted interest rates to 0.25 percent, the USDX traded at 100 for the first time since 2003.

Tourism and Trade

While a weak dollar may be disadvantageous for U.S. citizens vacationing abroad, it can present an opportunity for U.S. tourist attractions, making the country more inviting to international travelers. More significantly, a weak U.S. dollar can effectively reduce the country’s trade deficit. As U.S. exports become more competitive on the foreign market, U.S. producers allocate more resources to meet foreign demand. However, policy makers and business leaders disagree on whether a weaker or stronger currency is best to pursue. The weak-dollar debate remains a constant in 21st-century politics.

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