There are more reasons for the dollar’s economic weakness here

The weak dollar is causing the price of gold to rise and the Euro to appreciate.

In some respects, the US won’t mind a weak dollar at the moment. This is because:

• Weak dollar will help boost exports and limit imports. Overall domestic demand should be stronger
• It will help reduce their long term trade deficit.
• With inflation currently very low, they will not be worried about the inflationary impact of a depreciation.

The danger comes if the gradual depreciation becomes an a sharp fall because investors fear for the future of the US economy.

The Falling dollar is bad news for

• The Eurozone. With Eurozone in recession or growing very slowly. The appreciation of Euro against dollar will harm EU exports and make a sustained recovery difficult.
• Countries with Large Dollar Reserves. Since the US is the global reserve currency, most countries have exposure to the falling dollar and will see their dollar assets reduce in value. This may make it more difficult to attract foreign investors to buy US treasury bills to fund the US government deficit.

See also: Benefits and costs of a falling dollar

Recently the Canadian dollar has been weak against the US dollar. This is because of the plunge in commodity prices which depress Canadian export revenues and decrease value of Canadian Dollar.

Despite many problems in the US economy, the dollar has remained relatively strong, with markets taking the attitude – better the devil you know. (i.e. markets are feeling the US Dollar offers reasonably security compared to other countries – despite the US policy of quantitative easing and large national debt.)

source: Economist

Factors affecting Canadian Dollar in future months

The world economy may recover slowly which will help commodity prices increase, but, it is unlikely to be anything other than weak recovery.

The Canadian dollar is facing a similar rate of slowdown to the US economy. However, a stronger recovery is forecast for Canada. This could mean in 2010, Canada faces higher interest rates which attract hot money flows for Canadian dollar. This would increase value of Canadian dollar.

The dollar’s recent strength arguably rests on shaky foundations. With the impact of 0% interest rates, rising levels of national debt and quantitive easing, markets may feel the US dollar is overvalued and this could cause the Canadian dollar to rise compared to the US.

However, there are so many factors affecting exchange rates at the moment, it is difficult to make any predictions. However, on balance I’d rather be buying Canadian dollars than US dollars.

• Will US Dollar collapse?

(Disclaimer: Do not take this as investment advice)

In times of great uncertainty, gold often proves a good investment (see: Investing in Gold during times of recession)

Many factors still point to a weak dollar

• Very low interest rates
• Current account deficit
• Quantitative easing – increasing money supply
• Growing National debt

Some people believe with a combination of factors such as this there is a risk of a large depreciation in the dollar (See: Dollar in 2009) However, whilst dollar has risk of weakness, it must be remembered we face a global recession so all currencies / economies look threatened.

Last year, the dollar rallied as investors decided the dollar was probably better than many emerging economies.

I cannot give any predictions with certainty (I don’t think anyone can). At times like this there is a good case for diversification i.e. don’t put all your eggs in one basket.

The dollar has been falling for many reasons. These are some of the factors which would stop the dollar falling and lead to a recovery in the value of the dollar.

Higher Interest rates. US interest rates have been cut to 2% in an effort to stave off a US recession. This causes an outflow of hot money. If interest rates were raised it would encourage people to save in the US and cause an appreciation.

Recovery in US economy. The US fear recession because of a declining housing market, this is leading to lower interest rates and lower confidence about the US economy. If the economy recovered, interest rates would increase and people would have more confidence in buying dollars.

Fears Over the Euro. The main beneficiary of the falling dollar has been the Euro. People are increasingly seeing the Euro as an alternative reserve currency to the dollar. Therefore, investors have been switching out of the Dollar. However, confidence in the Euro may be misplaced. The Euro economy is not much stronger than the US. Many European economies face the prospect of falling house prices; also the strength of the Euro is causing problems for exporters. Arguably, the Euro is overvalued on economic fundamentals – the dollar looks cheap on purchasing power parity. Maybe the sell off of dollars has been overdone.

Improvement in US Current Account. The fastest depreciation in the dollar came when the US had a current account deficit of over 6% of GDP. However, the depreciation in the dollar is helping to improve the current account. If the current account continues to improve as domestic spending falls, the dollar should recover.

Intervention of Central Banks. So far, Central bankers have been content to leave the dollar to market forces. However, there may come a point when Central bankers think ‘enough is enough’ and they take steps to intervene in the market such as buying dollars. If there is co-operation on an international level, this may be sufficient to restore confidence in the dollar and revert its decline.

Improved US competitiveness. If US productivity improves relative to other countries this would help make US goods more attractive and increase demand for the dollar

The futures market suggest that there is a 45% chance of a base rate cut in April. The futures market is basically a representation of what investors think is going to happen. They buy options depending on what value they expect.

Although the pound has been weak against the Euro, the Pound’s strength against the dollar is likely to continue as the US economy continues to experience more problems. The Federal reserve has been keen to cut US interest rates and these lower interest rates have severely undermined the strength of the dollar.

Gisele Bündchen, a 27-year-old Brazilian model, is estimated to have a personal fortune of $150m (£72m) She is the face of numerous brands, but, appears to take a keen interest in financial markets. She is now insisting on negotiating contracts in Euro’s arguing that the dollar is likely to continue to remain weak in the coming year, (2008)

3 Reasons to get that $10,000 photo shoot in Euros rather than dollars.

• US Current Account deficit of 6% of GDP
• Falling US House prices, leading to slower growth and potential recession
• A slowdown in growth is likely to lead to lower interest rates in the US – lower interest rates will reduce hot money flows and further undermine the strength of the dollar.

See also:

• Predictions for US Dollar 2008
  
• Reasons for Fall in US dollar
• New low for the dollar at Independent
• Gisele Bundchen