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Is The US Economy Hurting The Value Of The US Dollar?

The latest announcement made by the US Fed and the impact of this on the value of the US dollar seems to suggest that the state of the economy is indeed affecting the value of the dollar. The latest Fed statement that it is prepared to provide further stimulus to the US economy is indicative of two points. First that the Fed is acknowledging that the US economy is still weak, and second that the Fed may undertake quantitative easing to address the situation of a weak economy.

The poor performance on the consumer spending, employment front, lower housing wealth and soft prices, seem to have urged the Fed to make such a statement. Overall, the US economy grew 1.6% in the second quarter as compared to 3.7% in the previous quarter reflecting the slowing pace of economic recovery. Quantitative easing will imply that the Fed is open to purchasing more assets and flooding the economy with more liquidity. This effectively implies that the supply of dollars in the economy will go up and the markets feel that the value of the dollar should fall in line with such an eventuality.

The immediate impact of the Fed statement was a loss in the value of the dollar versus major trading currencies like the Yen, the Euro and the Canadian dollar. Analysts have interpreted the US Fed statement to suggest that while the chances of a double dip recession have dipped, the risk of deflation is high. The Fed has indicated that it is uncomfortable with the present levels of inflation and may indulge in purchase of bonds. Quantitative easing or an increase in money supply could help counter deflation as there will be more money chasing the same goods and services in the economy, which could put an upward pressure on prices and ward off deflation.

Quite clearly, the slowdown in the US economy and the measures that the Fed could take to counter the slowdown are leading to loss in the value for the US dollar. While, the markets may have reacted sharply to the Fed announcement, the US dollar continues to be the major risk aversion currency and could rise in case of the announcement of any untoward economic development. Such a development could force investors to turn to the safety of the US dollar and make it go up.

The US Fed's announcement that it could take steps to stimulate the economy further led Asian stocks to recede, indicating some sellout. The funds from such sales could move back to US treasuries and boost the dollar, which would indicate the risk aversion sentiment. While, the Yen also acts as a risk aversion currency, any real substitute to the US dollar for the purpose is yet to be established.

However, the act of printing more money to induce inflation and to stimulate the economy could have an overbearing impact on the long term value of the US dollar. In the past, such acts have led to currencies plunging, though the US is likely to be careful in its quantitative easing such that no drastic fall takes place in the value of the dollar.

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