Dollar worries: Overdone or on the money?

In the weeks following the U.S. presidential election, dollar bears appeared to build renewed zeal. The euro pushed above the $1.34 level in early December while the dollar/yen dipped below Y102.00. In early December the dollar hit multi-year lows vs. several major currencies. By one trade weighted measure from the Federal Reserve Banks, the dollar fell nearly 29 percent from February 2002 against liquid currency pairs, excluding China.

A bear market in the greenback is firmly entrenched on the longer-term time frame, but many economists and market analysts are now questioning what the impact of continued deterioration in the U.S. dollar could have on the U.S. economy, stock and bond markets. For now, U.S. stock and bond market prices have not reacted sharply to the falling dollar. But, if the greenback continues to decline at a steady, strong pace, economists see a number of troublesome issues.

“If China and Japan lose interest in buying U.S. bonds to finance the deficit, it could become a financial crisis,” says Dave Sloan, economist at 4CAST Inc. He calls this a “realistic concern,” but adds that it is “difficult to know when it could happen.”

Another concern of market watchers is the potential inflationary pressure that a weaker dollar could bring.

“As the dollar falls, the price of imported goods rises,” says Sean Callow, currency strategist at Ideaglobal. “The pressure builds up for importers to pass along higher costs to consumers.”

That, in turn, could result in higher U.S. interest rates.