How the falling dollar affects Americans

The saga of the sagging dollar continues.

All year, the dollar has drooped compared with other major currencies. Last week, after the Federal Reserve reduced interest rates, it fell even further – now at a level not seen since 1997. The Canadian loonie is even stronger – on par with the greenback for the first time in 30 years.

But does a less prestigious portrait of George Washington (on the dollar bill) have any meaning for most Americans?

Economists say the falling dollar has pluses and minuses for the economy. For consumers who like to buy European automobiles or French cheeses, it means their standard of living will go down as they pay more money for these goods. But for American workers on the assembly lines at places such as Boeing or Caterpillar, it means their employers' products will be more in demand.

"After the pluses and minuses are all netted out, I think the lower-valued dollar is good for the economy," says Mark Zandi, chief economist at Moody's Economy.com. "The growth we're getting from trade is helping to cushion the blow to the economy from housing."

The last time that the buying power of the US dollar was this low was about a decade ago, according to Federal Reserve Board statistics. But the major difference was that the dollar was rebounding from its low point in the mid-1980s when the major industrial nations decided it was overvalued. It was also easier to make changes in the trade numbers because the price of oil ranged from $22 a barrel (in 2006 dollars) to $26 a barrel, and China's exports were tiny. The US trade deficit was about $230 billion.

This time, the dollar has been on the skids for the past five years. The price of oil is about $80 a barrel. The Census bureau reports the trade imbalance with China alone is $141 billion through July.

So far this year, the greenback is down 7.6 percent, including another 2 percent last week after the Fed reduced interest rates by half of a percentage point.

One of the greatest concerns is that a lower-valued dollar will add to the inflation rate, since imports could become more expensive. So far that hasn't shown up in the inflation numbers.

"It will take awhile to build into the system," says Bill Witherell, chief global economist at Cumberland Advisors in Vineland, N.J. "Right now, it's [inflation from imports] within the bounds which permitted the Fed to move."

However, some other economists aren't sure a falling dollar will help improve the trade deficit. They argue that the two major components of the trade deficit – oil and imports from China – are not really affected by the dollar gyrations. In July, the two areas represented 80 percent of America's trade imbalance.

"If you can't adjust imports of oil, and most are priced in dollars, and you can't adjust currencies against Chinese yuan, which is pegged to the dollar, depreciating the dollar does not get you where you want to go," says Peter Morici, an economics professor at the University of Maryland's business school.

Mr. Zandi, however, counters that the rising price of oil will eventually mean that Americans get serious about alternatives or cutting down on consumption. "It's having an impact, but it's just not as noticeable yet," he says.

He believes China's slow appreciation of its currency – about 10 percent in the past two years – will ultimately result in fewer Chinese exports. "It will have a big impact two to four years down the road," he predicts.

Some Federal Reserve watchers are not surprised that chairman Ben Bernanke opted to lower interest rates. Mr. Bernanke is a keen observer of the Great Depression in the 1930s. "In his studies of the Depression, one of his main criticisms is that the US was on the gold standard and did not get off of it," says Axel Merk, president of Merk Hard Currency Fund in Palo Alto, Calif. "Had they been able to lower the value of the dollar, Bernanke argues, "the officials could have reduced the hardship."

Some investors, including Mr. Merk, are skeptical that sacrificing the dollar is beneficial to an individual's pocketbook. Globally, that skepticism has seeped over into the gold market and is one reason the price of gold is now above $732 a troy ounce, a 27-year high. So far this year, gold is up about 15 percent.

"Gold appreciates as the dollar declines," says Merk.

So far the weak dollar has not kept investors from buying stocks, bonds, and real estate. The Dow Jones Industrial Average is up about 10.5 percent year-to-date and the Standard & Poor's 500 index is up 7.1 percent year-to-date.

"You could argue it's a problem if there is a rout of the dollar and it affects stock prices," says Zandi. "But we are not there yet, and as long as the decline is orderly, it is one of the key conduits which helps ease the problem."