The Dollar's Decline

A Big Mac Costs More
Have you traveled abroad lately? Was it expensive? Hopefully, you were prepared for goods and services of all kinds to cost more than they did last time you went. That's because the US dollar has been hitting new lows against major foreign currencies. This makes the dollar prices higher for anything denominated in those currencies.

An easy illustration is the "Big Mac Index". Several times a year, the Economist magazine publishes this compilation of world prices for McDonald's signature entrée around the globe, the Big Mac burger, and compares them with the respective dollar exchange rates. Recent listings were dated January 31 and July 2; we've made some calculations to cover currency rates through last week. A Big Mac in the US averages about $3.41, according to the Economist's July figures.

A standard price in the UK is £1.99. In January, this was the equivalent of $3.90; by July it was $4.01 and last week, $4.16, an overall increase of 6.7%. This is unpleasant, although not too severe. But in France, Germany and other Euro-Area nations, the increase has been noticeably greater. The burger ran about €2.94 back at the end of January; the $1.30/€ exchange rate meant it cost $3.82 then. Now, the euro price is €3.06, 4.1% higher, and the dollar has fallen 12.8% to $1.47/€. So a Big Mac now costs $4.49, a whopper of an increase totaling 17.5% (with apologies to Burger King).

But the euro differential is even mild compared with that for Canada. The Canadian dollar price moved from C$3.63 at end-January to C$3.88 in early July, a 7% rise. But the Canadian currency has come on really strongly, and frequent travelers to Toronto, Montreal and Vancouver are probably shell-shocked to find the traditional relationship upside down: now it's the Canadian dollar that's above par to the US dollar. The result for the US dollar price of a Big Mac in Canada is a move from US$3.08 in January to US$4.12 last week, more than a one-third increase. Ouch!

This is a massive erosion of dollar purchasing power. Our specific attention to this was grabbed by the Bloomberg news service story during the last week about the Brazilian supermodel, Gisele Bündchen, who has started requiring that her fees be paid in euros instead of dollars. She makes about $30 million a year, so this is no trivial matter for her. You, too, would want to be paid with something that will hold its value, so in the current atmosphere, we can understand this strategy. Ms. Bündchen isn't alone. The Chinese government indicated last week that it is becoming concerned that the dollar "is losing its status as the world currency". The Chinese hold $1.4 trillion in dollar reserves – that's "trillion", with a "tr-".

History Repeats
Such conditions have occurred before. In 1978 – we're old enough to remember! – there was a major dollar crisis and oil exporters were diversifying their "petro-dollar" holdings to marks, Swiss francs and yen. They also raised the dollar price of oil to maintain the purchasing power of their oil revenue.

What was going on then that set off such a run away from our currency? We were still reeling from the aftermath of a very unpopular war. Our government had been spending money on "guns and butter" both. We'd been caught flat-footed at the onset of an energy crisis and while some remedies had been tried, none really did anything substantive about our use of gasoline and other fuels. We had tried price controls instead of real reforms, resulting not in lower prices but in long lines at gas stations. Stock markets had stagnated and financial institutions were struggling under high and volatile interest rates. It was all very tough.

And it all sounds too familiar, doesn't it? Some of those same kinds of political, economic and financial circumstances are in play now. We're not here, as economists, to argue one way or another about the Iraq war or about the way-too-long Presidential campaign; indeed, we're restraining our rhetoric here. But others hear us all talk and they perceive our lack of decisiveness and will. The US is not acting like a strong nation, and the currency markets reflect this. We've exported our housing market woes; the international investors who've been burned clearly didn't have to buy those risky assets in the first place, but they have reason now to want to shy away from our markets and our currency. So too do American investors.

Here is a key point. All the factors that have recently hurt our currency and our market values affect domestic and foreign investors, business managers and consumers alike. Global markets mean we all share the pain of these developments together.

Trade, Politics and Energy Can Actually Help
How does this play out? Will our dollar and our markets continue to sink? There's way too much to say on this in a single article, but here are some thoughts.

First, some developments contain the seed of their own correction. As the dollar gets lower, the foreign currency prices of goods and services also decline, and US products become "cheap". So US exports are growing very rapidly. September data on foreign trade published Friday show them up almost 14% from a year ago. If you live in a tourist locale, you've perhaps noticed many more foreign visitors, whose spending in the US counts as "exports" too. And we've heard stories of Canadians coming across the border to shop; the currency savings more than offset the cost of traveling to a gateway city. US imports, by contrast, have risen less than 4% over the last year, despite the higher prices that raise their nominal values. Consequently, the overall trade balance is diminishing: in September it was "just" $56.5 billion, the smallest monthly shortfall since May 2005, and $11 billion smaller than the largest monthly deficit, $67.6 billion in August 2006.

Secondly, time will pass and the long-awaited Presidential primaries will finally arrive. Perhaps the beginnings of our electoral process will help settle the nerves of foreign investors.

Third, as we have highlighted here before, US energy consumption is generally flattening out. Unlike the late 1970s episode, when total BTUs (not just petroleum, but all types of energy) were expanding as much as 5% a year, the most recent months are up at just a bit over a 1% pace and consumption in some months has been below the year earlier. Petroleum consumption has hardly moved at all since the beginning of 2006. Spreading "green" strategies among consumers and businesses, who find they can actually profit from greater energy productivity, will carry this trend farther, perhaps to outright declines.

Finally, the financial markets' dislocations will likely continue for some time. But efforts toward fixing what's broken are under way. So it looks to us that the worst news is out. That, of course, doesn't necessarily mean that better news will come anytime soon.

Real Solutions Needed, Not Band-Aids
So many questions remain. Tonight as we write (Sunday, November 11), Asian markets are trading during their Monday workday. Several countries, including India and Korea, are announcing currency controls, bureaucratic hoops meant to make it harder for traders to sell dollars and drive their own currencies still higher. Such regulatory actions, including trade restrictions, may buy time, but they are not real answers. Real answers, we learned in 1978 and 1979, involve real adjustments in the US economy itself.

In addition, it's important to remember that exchange rates are the ratio of two currencies, so developments in the other country count too. Canada benefits from the high and rising oil receipts and Europe's 9-year-old euro currency system is maturing and finding its footing. Favorable trends abroad -- which we can hardly begrudge them -- have combined with malaise at home to drive the dollar down.