I’m as surprised as anyone over the continued weakness of the US dollar. I thought the greenback would see some stabilization after reaching parity with the loonie but its value has continued tumbling and it’s now worth slightly less than $0.91 CAD. If you look over at Reddit there’s hardly a day that goes by nowadays without 2 or 3 new stories on the subject. Here’s how I see the current crisis.What’s happening is that foreign traders see that the subprime lending mess is leading to a tightening of credit practices in a country whose economic well-being is pretty much dependent on the widespread availability of cheap credit. Selling off dollars happens because of doubts about the strength of the economic in the short to medium term.On top of that you have an increasing number of countries who no longer require that large purchases of expensive items — like oil — be paid in US dollars. In the most famous example of this, Iran now asks the Japanese to pay for their oil import in yen instead of dollars. Previously the Japanese would be obligated to purchase USD to pay for their purchases. Not having this requirement is leading to a drop in demand for US currency, which complicates the problem.
Adding to all this, the Feds are cutting the prime rate on the USD in order to promote the continuing existence of cheap credit, which is supposed to spur consumer spending (it doesn’t seem to have much success so far, look at the consumer confidence numbers) but also has the side effect of reducing the value of the USD as an investment.
This is trouble for the US. The worst of the subprime mass has yet to pass, which means that the problems that started the dollar’s freefall are only going to get worse. Other countries have no interest in forcing their customers to make purchases in USD, because this would increase their customers’ costs of doing business — and also because the value of the USD is still falling. Finally, the Fed has to continue wandering on the edge of Occam’s Razor — lower interest rates and the value of the dollar will continue to fall, probably causing inflation to rise; leave them (or raise them) and you might trigger a recession.
In short, there’s not really an easy way out of this mess, and that’s chiefly why the USD is still seen as overvalued (!). It’s a sort of “perfect storm” kind of scenario. Things will have to get worse before they get better.
Note: I wrote the first draft of this as a comment on Reddit and did a little editing on it.