As the US dollar hovers below its record lows against the major European currencies and many other world currencies, some… … economists and foreign exchange market professionals have expressed concern that the dollar may be on the brink of a major collapse.

They note that the already weak dollar could be devastated if the US housing market and mortgage industry do not show signs of a bottom and a solid potential for recovery.

The Euro is currently (December 13, 2007, 3:40 EST) netting $1.466, which is only a couple pips below its all-time record high set earlier this month. The British Pound is currently trading for $2.0388, also a few pips from its high. The dollar has jumped back to a value of 112.31 Japanese Yen.

While the dollar’s historic weakness against the European currencies is due largely to economic variables including more stable economic conditions in Europe, and the obvious housing and mortgage struggles in the US, the dollars level against the Yen, which is well below its record high above 125 Yen earlier this year, is more a condition of overall global uncertainty, which has caused many speculators to back out of carry trades.

In the currency trading world, carry trades are trades designed to take advantage of interest rate differentials. Traders may buy US dollars or European currencies to collect higher interest rates, while borrowing low interest products like the Yen. The differential carry leads to a daily rollover of the interest differential which provides medium to long term traders an opportunity to earn significant interest that helps offset poor business conditions or negative currency moves over time.

However, when the economy becomes unstable and investors begin to avoid more risky investments, carry traders tend to reduce or withdraw their involvement in high risk speculation. This means carry trades, designed to optimize currency trade in a stable, growing environment, see a turnaround. Carry trades have recently tended to move with the stock market in near parallel as investors move in and out based on the economy and the latest news on struggling markets. The US dollar has seen the greatest drop against the Yen as it has fallen across the board against foreign market currencies.

While the basic flow of currency value tends to revolve around the overall economic picture in countries that use the currency, speculators have a great impact on the severity and rapid reversal of direction of currencies. Like all markets, currency investment tends to operate on a futuristic basis. As the stock market fluctuates based on news, and hopes or fears, currency traders react to news with a potential economic impact by getting in or out of currencies impacted. Thus, currency markets often move in advance of actual economic events.

From a market perspective, although traders have impacted the dollars move significantly, the slumping US housing market and mortgage markets have been the economic engine directing the dollars decline against other major currencies. The dollar loses value in the world market when speculators, businesses, government entities, and other agencies decide through their business practices and trades that the US market and the dollar are not a good investment relative to other markets.

With the current uncertain state of the US economy, and in particular, the housing and financial services markets, many are choosing to invest in the more steady European currencies. Australia and New Zealand, which currently are among the higher interest rates in the world, appear to be a half cycle behind the US. They have recently seen peaks in their economies and housing markets as the US reaches bottom. This has made their currencies more attractive to foreign investors and currency markets in the last couple years.

How does the dollar decline impact a typical American? In simplest terms, a lower valued dollar makes it more difficult for Americans to afford travel abroad as their US dollars will not buy as much in foreign markets as it would during a high dollar situation. Similarly, many US based businesses have a hard time investing in foreign markets as foreign investments seem expensive when purchased with a lower valued currency. On the contrary, US exporters see a great benefit from a lowered dollar, as their goods seem cheaper in foreign markets with more powerful currencies.

Ultimately, while imported products are less attractive to US markets during a dollar decline, outside of slightly higher retail prices in some industries, average Americans typically do not notice much direct impact from a dollar decline. In fact, this sometimes healthy market reality is needed to help reduce the US trade deficit, as it creates greater world interest in purchasing cheaper, US goods.

Market Recap

The US equities markets have been very choppy the last two trading days following the sharp drop Tuesday as the Fed’s unenthusiastic ¼ point interest rate reduction was announced. Wednesday’s market traded relatively flat before closing up slightly. Thursday’s market may have been an encouraging day to some traders as the market jumped out to an early deficit of over 100 points in the Dow, before surging to an almost 170 point turnaround on the day, and a close of 13,517.96, up 44 points. The NASDAQ and S&P both closed relatively flat on the day, with the NASDAQ down slightly at -2.65 to close at 2,668.49. Rising wholesale prices were the biggest newsmaker in the market today, but the top national story of interest was the Mitchell Report regarding the ongoing Steroids scandal in baseball, which named about 80 current and former MLB players linked to steroids or human growth hormones.

Neil Kokemuller
Thursday, December 13, 2007
7:24 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University with a specialization in marketing.

Please note: The information provided in this article is intended for informational and entertainment purposes, and not as advice for financial decisions or investments. Actions taken on the basis of the information shared is at the sole risk and discretion of the individual.