Thursday, September 24, 2009

Dollar Nearing a Critical Level

Calafia Beach Pundit

This chart is arguably the best way to look at the dollar's value vis a vis the currencies of our trading partners, because it uses a very large basket of currencies and makes adjustments for cross-border inflation differentials. As you can see, the dollar is about 7% above its all-time low, a level that has provided solid support three times in the past.

In today's world of floating currencies, almost every currency rises and falls against other currencies at one time or another. But a currency that is persistently weak or continually falling relative to others presents a problem. If the dollar's value were to continue to fall to new lows, eventually this would trigger rising inflation pressures. Indeed, supply-siders usually assume that any significant decline in a currency's value (particularly against gold) is a sign of easy money and therefore rising inflation risk. That's because inflation can be defined as the loss of purchasing power of a unit of currency.

Weak and falling currencies are also bad for growth, since they scare away investment. Who wants to invest in a country if there exists the real possibility that one's investment will be eroded by a falling currency? At the very least investors require special incentives (i.e., premiums) to invest in an economy with a weak currency.

Dollar Nearing a Critical Level

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