Why Dollar May Be Set for a Rebound
Beating down the dollar has become a popular sport lately. But the greenback may be about to get off the mat.</br></br>The dollar's decline this year has been unrelenting. It has fallen 5% against the pound, 7% against the yen, 10% against the euro and 14% against the Canadian dollar. Against the Federal Reserve's trade- weighted basket of currencies, the dollar has dropped 8%.</br></br>For years, most economists have viewed the dollar as an accident waiting to happen. To finance its huge trade deficit, the U.S. has been borrowing heavily from the rest of the world. The thinking was that overseas savers eventually would tire of holding ever-greater quantities of dollar-based assets. When they'd had enough, the dollar would fall.</br></br>And so it has. Many economists think the dollar will weaken further. Maurice Obstfeld of the University of California at Berkeley and Kenneth Rogoff of Harvard University calculated in 2005 that with the broadest measure of the U.S. trade deficit -- the current account -- running at more than 6% of the nation's economic output, the dollar needed to fall as much as 30% against the Fed's currency basket to bring the trade deficit back into balance. (A weaker dollar makes U.S. exports cheaper to foreigners and makes imports costlier for Americans, shrinking the trade gap, as has been happening lately.)</br></br>By that reckoning, the dollar needs to drop an additional 20%. And the Fed's new openness to cutting interest rates, if the textbooks are right, should further weaken the currency as global investors flock to places with higher returns.