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It brings inflation relief but could stifle exports

WASHINGTON: The US dollar’s recent gains are cutting both ways for the country, cooling inflationary pressures but also threatening to choke exports, the life support for the ailing American economy.

The greenback, which fell to a record US$1.60 against the euro in the middle of last month, has since enjoyed a month-long rebound.

The upward trend, however, has zigzags. Late on Tuesday, the dollar slipped back on a pair of worrying United States economic indicators, pushing the euro up to US$1.478 in New York.

‘The appreciation will continue; it’s not going to be all straight line after such a huge advance that we’ve seen in the last couple of weeks. You get some consolidation and it gives back a little bit before resuming the stronger path,’ said Mr Stephen Gallagher of Societe Generale.

‘In the next six months, we can look to move to US$1.40 versus the euro.’

The reason for the dollar’s ascendance, economists say, is the growing pessimism about the health of euro zone and Japanese economies, rather than renewed confidence in the US economy.

‘A few months ago, people were talking a lot about decoupling and that the global economy would do fine even if the US economy was stepping into recession,’ Mr Gallagher said.

The market has undergone a major re-evaluation of that theory in recent weeks, he said, and come to ‘the recognition that the US consumer is in a weak state and that the rest of the world economy would also suffer because of that’.

Nonetheless, the rise in the dollar is positive for the US economy on the inflation front, analysts noted, as it often comes with a drop in energy prices.

‘Oil by itself coming down is a good thing, the US dollar going up by itself is a good thing, both from an inflation standpoint because they are disinflationary,’ said Mr Drew Matus, a senior US economist at Merrill Lynch.

A stronger dollar makes imports cheaper, thus limiting the risks of ‘importing’ inflation.

Federal Reserve chairman Ben Bernanke in June voiced concern about the risks of a weak dollar undermining price stability as the sluggish economy battles housing and credit headwinds.

The dollar’s new buying power should bring inflation relief after consumer prices leapt 5.6 per cent last month to a 17-year high.

But if it costs less to import, exports become more expensive.

And if the recovery of the dollar stems from deteriorating global economic growth, Americans will see exports dwindle. That poses a risk for US growth, since foreign trade is currently one of the few engines firing in the economy.

‘Obviously, if the appreciation continues to occur, it might dampen some of the export growth we’ve been experiencing,’ Mr Matus said.

He recalled that in the trade sector, ‘it takes a long time for the exchange rates to play out’ - from six to 12 months. ‘That’s why it took a long time for the US economy to get a boost from the weakening dollar,’ he said.

US companies will likely be the first to feel the effects of the stronger dollar. While most of the major firms have posted strong results recently, ‘it’s because they have greatly benefited from the strength of exports’, said Mr Gregori Volokhin at Meeschaert Capital Markets.

AGENCE FRANCE-PRESSE

Source : Straits Times - 21 Aug 2008