Term Paper on "Dollar Depreciation Economic Effects of U.S"

Term Paper 11 pages (3472 words) Sources: 5

[EXCERPT] . . . .

Dollar Depreciation

Economic Effects of U.S. Dollar Depreciation

News on the effects of the deprecation of the U.S. dollar depends on the source. Opinions on the effects of U.S. dollar depreciation range from gloom and doom to hardly any effect at all. The depreciation of the U.S. dollar has an effect on the willingness of people to incur major debt or to engage in travel. Whether the reports are minimizing a real problem or inflating a minor occurrence, the news and speculation alone have the ability to change consumer habits, both in the U.S. And abroad. This research will investigate the hypothesis that the depreciating dollar will help to rebalance the trade deficit, resulting in a stronger overall global economy.

Understanding Dollar Depreciation

Americans are used to living in a country where dollar depreciation was not a problem. They became accustomed to a relatively stable dollar, compared to other countries. The dollar has been historically so stable that it has been used as the standard against which to measure other forms of currency. However, recent depreciation of the dollar has left many Americans weary of their spending habits. One of the key reasons for the panic is that Americans are simply not accustomed to the level of instability recently experienced. This is the key reason that underlies the hype regarding depreciation of the dollar.

The reasons for the depreciation are not difficult to understand from an economic standpoint. Depreciation of the dollar is a result of the U.S. government borrowing nearly $665 billion annually from foreign lenders. These funds are being used to finance the gap between payments to and receipts from other countries (Rivens, 2004). This price tag amounts to approximately $5,500 per household every year. This level of borrowing is not new and has been going on for quite sometime. Borrowing entails a cost, whether the borrower is an individual, business, or the U.S. government. However, the American public did not notice it, as it was offset by low interest rates (Rivens, 2004). This is no longer the case and the average American is beginning to feel the crunch.

The current trade deficit has been driven largely by the merchandise trade account. Merchandise accounts for nearly 90% of the current debt of the United States (Rivens, 2004). The current problems began in 1997 with a rise in the value of the dollar. As the dollar rose, U.S. demand for imports rose due to falling prices. However, the other side of the coin is that as the cost of imports fell, the cost of exports rose. This lowered demand for U.S. products and increased demand for foreign products (Rivens, 2004).

Eventually outstanding accounts outpaced accounts receivable and the U.S. was soon in a borrowing, rather than profit position. A small debt to income is not problematic, as long as it is resolved before it grows too large. However, this is not what happened with the U.S. economy. Demand for imports continued to grow and demands for exports continued to fall. The trend was not steady by any measure, and there were brief periods where it looked like the U.S. might be on the road to recovery. However, these periods were short-lived and over the long-term, the debt grew, as compared to revenues from exports. By 2004, the trade deficit was equal to 5.2% of the GDP (Rivens, 2004).

Dollar Depreciation and Global Competitiveness

One of the key advantages that made the dollar attractive is the competitiveness of the U.S. In the global marketplace. The U.S. was an early player in the global marketplace, largely due to advances in technology and a highly developed infrastructure. This created a ripe environment for American ingenuity and the development of manufacturing enterprises. For many decades, the U.S. And other industrialized nations enjoyed a narrow competitive outlook. The number of producers that could compete on a global basis was limited by technology and access to the market. This allowed these countries to gain market domination, allowing their economies to grow strong.

However, this has changed. Communication advances have allowed countries that were unable to compete on a global basis to enter the global marketplace. The former superpowers are losing ground to competition. Even if the new comers to the global market do not achieve domination over the larger industrialized nations, they can still take a bite out of the market share. This reduces the chance for export revenue as the U.S. And other industrialized nations receive an increasingly smaller piece of the pie. The global marketplace is no longer a cornered marketplace for the U.S.

As newcomers become more competitive, the U.S. must take actions to make their goods and services more attractive to foreign markets. The current dollar depreciation is a correction that was foreseeable to economists long ago (Rivens, 2004). The depreciating U.S. dollar means lower export costs and will increase demand for U.S. products, at least in theory. The effects of this correction will have differing outcomes for each individual country that is a trading partner. For instance, the dollar correction as compared to the euro has recently experienced dramatic shifts (Rivens, 2004). This is the first step to correcting current account deficits (Rivens, 2004).

China, Malaysia, and Taiwan enforce a hard peg of their currencies in relation to the valuation of the dollar (Rivens, 2004). These countries will buy mass amounts of U.S. dollars on the global market in order to stabilize their own currencies. They do not allow fluctuations of their currencies to expand outside of a predetermined narrow band (Rivens, 2004). Current fluctuations in the U.S. dollar may force them to change their fiscal policy in regards to the U.S. dollar.

What does the future look like?

The costs of the debt remained cleverly hidden by the Federal Reserve's attempts to hold down interest rates. However, recent economic shifts have prompted them to increase interest rates. The American citizens are now beginning to notice their declining dollar. Continued borrowing will have dire consequences, according to some experts. It is projected that if the current account deficit continues to rise at the current rate the external debt of the United States will increase to 64% of the national GDP by 2014 (Rivens, 2004).

This means that a majority of the GDP will be spent financing debt, rather than being used for programs and infrastructure improvements. This is a bleak picture for the American citizen because it could mean higher taxes, higher interest rates, and an even greater depreciated dollar value. This is the opinion of many gloom and doom analysts, who project that the good times are over for the American public.

This opinion does not consider the positive effects of dollar depreciation, which will be discussed later. However, for now, let us assume that the bearish trend will continue and the purchasing power of the American citizen will decline. This projection suggests that the government will continue to spend more than it earns and that the debt will outpace income at an increasing rate (CBO, 2004). The following is a projection of the how the bottom line for the United States may look if the current trend continues. (Source: Congressional Budget Office. 2004. Current Economic Projections, 2004-2014. In Rivens, 2004)

When the U.S. is in a higher debt to income position, it has the effect of decreasing the value of the U.S. dollar, as compared to other currencies of the world. This will reduce the value of future income generated by capital stock (Rivens, 2004). As the debt continues to grow it will place intense pressure the ability of Americans to continue their current living standards. However, only the future knows if the current predictions will hold true. The Central Budgeting Office feels that the debt will continue to grow. However, these projections are based on a number of assumptions that may or may not hold true in actuality.

The current dollar correction will help to stabilize the import/export ratio of U.S. goods. However, the real question is how long the correction will continue. Some analysts paint a glum picture where the dollar will continue to fall even more dramatically in the future. These analysts contend that continued dollar depreciation will have a negative impact on the economy (Obstfeld & Rogoff, 2005). However, other feels that the response to the correction has been sufficient to project that it may be at it lowest, or near its lowest (Corsetti, 2007). Both of these opposing views on the future of the U.S. dollar are based on different factors.

According to the IMF, the current U.S. dollar depreciation is a part of the natural rebalancing process and will have a positive effect on the global economy (Reuters, 2007). The IMF feels that the U.S. dollar is a heavily overvalued currency and that the adjustment had been fairly controlled so far. This statement brings up another important point when considering the effects of the depreciation of the U.S. dollar. If one tends to read only U.S. based economists commenting on the effects… READ MORE

How to Reference "Dollar Depreciation Economic Effects of U.S" Term Paper in a Bibliography

Related Term Papers:

U.S. Trade Deficit Term Paper

U.S. Trade Deficit

United States Trade Deficit

The balance of trade is an economic measurement highlighting, amongst other things, the health and stability of a national economy. It is calculated… read more

Term Paper 5 pages (1598 words) Sources: 4 Topic: Economics / Finance / Banking

---

Economic Benefits of Buy a House Get a Green Card Research Proposal

Buy a House, Get a Green Card

Fundamental objective of this proposal is to present the economic benefits of "Buy a House, Get a Green Card." Implementation of the proposal… read more

Research Proposal 8 pages (2613 words) Sources: 8 Topic: Economics / Finance / Banking

---

U.S. Trade Balance and Exchange Rate Term Paper

U.S. Trade Balance & Exchange Rate

US Trade Balance and Exchange Rate

Most economists agree that there is a definite relationship between trade balance and the exchange rate. It is… read more

Term Paper 6 pages (2380 words) Sources: 1+ Topic: Economics / Finance / Banking

---

Relationship Between Population Growth and Economic Development Term Paper

Economics

Relationship Between Population Growth

And Economic Development

This report aims to discuss some of the relationships between population growth and economic development. Economic growth is an objective of every… read more

Term Paper 6 pages (2737 words) Sources: 0 Topic: Economics / Finance / Banking

---

Economics: Macroeconomics Chapter

iv) An American firm trying to purchase property in Hong Kong

The firm would benefit from such depreciation because most Hong Kong-based investors wishing to purchase property in the U.S.… read more

Chapter 5 pages (2355 words) Sources: 1+ Topic: Economics / Finance / Banking

---

View 100+ more related papers  >>