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  1. 1. NOVAK DJOKOVIC GROUP The Fluctuations of US dollar & its effects towards the world Economy Table of Contents Page1.0 ABSTRACT..................................................................................................................... 12.0 INTRODUCTION ............................................................................................................ 13.0 OBJECTIVES ................................................................................................................. 34.0 LITERATURE REVIEW .................................................................................................. 35.0 DISCUSSION AND FINDINGS ....................................................................................... 9 5.1 The Factors That Influence the US Dollar ................................................................... 9 5.2 The US Dollar Fluctuation Affected the World Economy........................................... 11 5.3 The Countries Have Been Affected .......................................................................... 14 5.4 Policy to Response ................................................................................................... 196.0 CONCLUSION .............................................................................................................. 21REFERENCES
  2. 2. 1.0 ABSTRACTThis paper ties to study the fluctuations of US dollar and its effects towards the world economy.It shows that the fluctuations of the US dollar are definitely bringing impacts towards the worldeconomy. From the research, we know that trade deficit versus the US dollar index, housingbubble, size and liquidity of asset markets, interest rates, currency pegs, market psychology,inflation and gold fundamentals is the key that affecting the US dollar and cause thefluctuations. We also noticed that several countries are being affected. Lastly, Americangovernment takes few policies to fight against the fluctuation of the dollar, which is FOREX,monetary policy, fiscal policy and federal debt and the lower foreign trade barriers. 2.0 INTRODUCTIONThe US dollar is the significant dominant currency of the world economy for almost a century.There are no other economy came close to the size of the United States. Although the Chinaeconomy is rising, but it still cannot overtake the powerful United States. The US dollar hadbeen the de facto world reserve currency, which means that the US currency accounted forroughly two thirds of all official exchange reserves. The US dollar is denominated in more thanfour-fifths of all foreign exchange transactions and half of all world exports, and all of the IMFloans. Therefore, the major movements in US dollar have important implications for theprospects for the world economic growth. An increase of the US dollar will lead the purchasing power of US consumers, andfollowing with the import demand. The higher import demand in United States will bring theimproved of the export and the economic performance in many international economiesespecially those in European countries, Asia and Latin America. However, if the US dollar wentdownturn in short period, this will bring the huge impact on the world economic growth. Theworld commodity demand and prices will be affected. The reason of the world economydependent very much on the United States as a growth engine, therefore once the US dollardepreciate, it will cause the reduction in US import demand and potentially to weaken the worldeconomic growth. From a peak in early 2002 through the first half of 2008, the US dollar steadilydepreciated, dropping a total of about 25 %. In between, the US dollar has once sharplyappreciated, increasing more than 11% on a trade- weighted basis. However, the US dollar 1
  3. 3. began to turn down again and fell about 16% in mid-2009 to mid-2011. The market uncertaintybecause of the European sovereign debt crisis caused the dollar to appreciate more than 5%through the end of 2011. In contrast, the dollar is again depreciation in the early 2012 becauseof the return of some degree of financial normalcy in Europe. The dollar dropping from early2002 through early 2008 as well as the recent depreciation has not been uniform againstindividual currencies, however, in the earlier period, it drop 45 % against the euro, 24% againstthe yen, 18% against the Yuan and 17% against the Mexican peso. US dollar also has a toughperiod in the business cycle in middle 2009. The fading of the dollar raises concern inCongress and among the public that the dollar’s decrease is a symptom of broader economicproblems, such as a weak economic recovery, the increasing of public debt and the diminishedstanding in the global economy. However, the dollar is still the world’s ‘safe haven’ currency. According to FortuneMagazine (2011), the federal deficit and debt burden of America are ballooning; the trade areimbalances with emerging countries are gaping wider. Then, the Federal Reserve has beenprinting new money, diluting the value of each existing buck. Laurence Kotlikoff, an economicsprofessor at Boston University said that the United States is basically bankrupt, and it is themajor decline in the dollar over time. Besides that, United States also has the longer period ofthe highest poverty rates in the developed world. According to Reuters (2010), the number ofAmericans living below the poverty line rose to a new record of 46 million on the year 2009,and this is a big challenge that The President Barack Obama and Congress faced, and they tryto tackle high unemployment and a moribund economy. It is striking perception that the weakness of dollar will bring the yield economicexpansion without any reference to the structure of financial institutions in nations of Japan,China or Europe. Koo (2003) also declared that the world is now entering the balance sheetrecession, which a big number of companies in economy no more fight for maximum profits butare trying hard to strengthen their balance sheets after facing a major fall in asset prices. Thehousehold sector still saving money while the corporate sector is no longer borrowing money,this kind of fallacy of composition problem is created and pushes the economy ever deeper intorecession. Therefore, the United States have to try hard and figure out the best way to reducethe harm of the fluctuation of US dollar towards the world economy. The figure below has shown the fluctuation of dollar for these recent years. The trendof dollar is decreasing. 2
  4. 4. Figure 1: Index of Trade-Weighted Exchange Rate of Dollar Sources: Board of Governors of the Federal Reserve System 3.0 OBJECTIVESThe objective of this study is to investigate the factors that influence the US dollar. Secondly, isto determine the impact of the US dollar fluctuation towards the world economy, and thecountries that have been affected the most. Lastly objective is to evaluate the policy that hasbeen implementing to the fluctuations of US dollar. 4.0 LITERATURE REVIEWAccording to Barro (1986), U.S. dollar is used by the people as the basis for spot agreementsas well as for long term contracts. The inflation is associated with the U.S. dollar. Increasedvolatility of nominal interest rates can have important effect on the required average real rate ofreturn on nominally denominated assets. Higher expected inflation tends to go along with lowrealized returns on holdings of long term bonds. Future contracts in price indices wouldalleviate the adverse consequences if expenses. The uncertainty inflation, cause the marketparticipants have serious problems in evaluating the real implications of nominally denominatedcontracts, including dollar bonds. The effect on the risk and premium bonds depends on theincrease on the interest rates and tend to go along with good or bad economics. This could 3
  5. 5. affect the fluctuations of the U.S. dollar. If good times, bonds do badly in good times and viceversa, which is desirably property that is consistent with low mean real rate of return on bonds. In currency fluctuations a danger for firm operating globally, Casacchia (2007) affirmed thatmultinational corporations are not doing enough to mitigate the risk associated with currencyfluctuations, unprepared for the financial hits. Foreign exchange risk is one element of thevolatility can manage and diversify. Political and changing of the economic views can changebusiness operations unexpectedly. The lower dollar certainly attracts tourist and spurs exportssales in the U.S. American businesses pay more for imported goods. The difference of theforeign exchange cause British and Canadian lost millions as their currencies continue itsappreciation. The transaction and the volatility of the U.S. dollar and other currencies introducethe risk to bottom line. Dollars crept to new low and weaken the other currencies. According to KPMG LLP (2009), the shockwaves from the credit crisis have buffetedthe U.S. dollar and weakened dramatically against the euro. Although the dollar regainedground in the second half of 2008 after Congress passed the financial rescue packagedesigned to stem the liquidity crisis, it is still weak. A weaker dollar has been good for U.Smanufacturers in exports, making them more cost-competitive in foreign markets. However, theimpact of credit crisis has weakened consumer confidence, tighter credit markets,unpredictable commodity and raw materials costs and the impact of at least a short-termeconomic recession. To ride out the challenges ahead, the U.S, manufacturers can managetheir currency risk and balance their global investments by develop a foreign exchange risk-management plan. The risks are transaction risk, translation risk, and economic risk. Next is tounderstand where the exposure lie is and use hedging strategies to lower financial risk.Moreover, establish the most favourable currency for transaction using spot transaction,forward contracts and option contracts. Besides that, break down organizational silos and lastlyis pursue operational hedging by paying in local currencies where possible and considerevaluating their global operations in the same way they would any other global asset portfolio. KPMG LLP (2009) also stated that with the currency and commodity market volatilitypotentially having a direct impact on the profitability of a given product, the ability to gatherinformed analysis on price, supply, and demand risks is essential. Nevertheless, if the currencyexposures are well understood, evaluated, and quantified, a manufacturer can risk not onlymargin and profit disruptions, but also a corresponding impact on share prices. 4
  6. 6. Madueme (2010) claimed that the British pounds had the highest impact onfluctuations in the United States dollars followed by the Euro then the Canadian dollar. TheUnited States dollar decreases 2.6% and 2% each when one unit increases in British poundand Canadian dollar respectively. Those with lesser impacts are the Indian Rupee and theChinese Yuan while the Japanese Yen has the least impact on fluctuations in the United Statesdollar. One unit of Japanese Yen increases the United States dollar by 0.001%. According to Jayakumar and Weiss (2011), the American unipolar moment has faded.The United State has no more hegemonic stability and unipolarity in the global reservecurrency. The future of global economy will revolve around a multipolar order with the rise ofChina. China is now quickly redrawing the traditional Western dominated global economicsystem. The attractiveness of the dollar standard diminish because of the structural challengesthat faced by the American economy which come along with the extraordinary expansion ofFederal Reserve’s balance sheet and the explosion of US government debt. The Global CreditCrisis of 2008 – 2009 is the key point that causes the American unipolar to fade and bring therise of the China. The dollar’s pre-eminent status as the world’s reserve currency is expected togive away over the next two decades because of the rising of the euro and the Yuan. This willbe the three primary reserve currencies, with no single currency enjoying significant dominanceover the others. Lastly, the shift away of the dollar centric global monetary order to a triploidcurrency order is likely to have significant repercussions for the global economic system. Penm, Maurer, Fairhead and Tran (2002) stated that the depreciation of the USexchange rate will definitely affect the world economic growth and the world commoditydemand and prices. The significant impacts could be expected on Australian exports oflivestock products, minerals, and energy commodities which are sensitive to the world incomechanges. The direction of movements in the Australian dollar is the vital factor in assessing theimplications for Australian commodity exports. A significant appreciation of the Australian dollaragainst the US dollar would obviously decrease the earnings for the commodity exporters andproducers. According to Goldberg and Crockett (1998) the year 1997 and 1998, the U.S. dollarincreased in value relative to the currencies of its trading partners. A dollar appreciation canaffect U.S. manufacturers’ revenues in two ways. First, a stronger dollar pushes up the price ofU.S. goods in export markets, making those goods much less attractive to foreign buyers andreduced export sales for U.S. producers. Second, a stronger dollar can jeopardize the domestic 5
  7. 7. sales of U.S. manufacturers by giving the foreign producers that have penetrated U.S. marketsa competitive edge in pricing. If the increase in net external orientation means that a strongdollar could generate larger declines in revenues than in costs, we would expect a dollarappreciation to lead to a drop in overall profitability. From using nationally aggregated data for the 1975-93 periods, finds that a permanent1 percent real appreciation of the dollar reduces real U.S. manufacturing profits by roughly 1percent over the long run. Previous researcher confirms the expectation that a stronger dollarwill lead industries to reduce investment spending. Another factor is industry profit structure,when the dollar rises, the most extensive cuts in investment spending occur in industries withthe lowest price over cost mark ups. Stronger dollar is correlated with job losses in some states.Recent studies have confirmed expectations that a dollar appreciation will significantly reduceproducer profits and restrain investment spending. Strong dollar depresses wage growth andmay create churning in many industries. Waring (2009) said the main reasons that many countries hold U.S. dollars is so theycan use those dollars to fix the value of their currency to the U.S. dollar. Before the September11th attacks, the U.S. dollar was considered a ‘safe haven’ currency which would strengthen intimes of global uncertainty, as the United States was considered one of the safest and moststable places in the world. However, the events of September 11th diminished the U.S. dollar’sstatus as a safe haven currency and it has struggled to regain this status ever since.Manycommodities such as gold and crude oil are quoted in U.S. dollars in the international markets.Many countries use the U.S. dollar in international transactions for this reason. This creates alot of demand for the dollar, which helps keep the foreign appetite for the currency strong. thefactors that traders watch when trying to determine the long-term fundamental position of thedollar. These factors are The dollar’s status as the world’s reserve currency ,Countrieswillingness to use the U.S. dollar in their ,currency pegs and the soundness of thosepegs ,Foreign interest in the U.S. dollar and dollar denominated assets from individuals andcorporations and The pricing in dollars of commodities in international markets. The factor that contributes to the fluctuation of U.S. dollar includes the relationshipbetween the crude oil price and exchange rates. Yousefi and Wirjanto (2004) showed thatwhen the U.S. dollar depreciates (appreciates), oil suppliers tend to raise (lower) export pricesin order to maintain their mutual level of revenue. It can be seen that the majority of crude oiltrading takes place in U.S. dollars, and that oil is still the world’s primary energy source, it 6
  8. 8. makes sense that variations in the international trading of crude oil should have a significantimpact on the relative valuation of the U.S. dollar (USD). Somehow, there are also provided indirect evidence that USD exchange rates have asignificant influence on the oil price. For example, Indjehagopian, Lantz, and Simon (2000)found that variations in the DEM/USD and FRF/USD rates had an immediate impact onGerman, French, and Rotterdam heating oil prices. Sadosky (2000) showed that the effectiveUSD exchange rate transmitted a shock to crude oil, heating oil, and unleaded gasoline prices.Yousefi and Wirjanto (2004) demonstrated that the export prices of crude oil from OPEC(Organization of Petroleum-Exporting Countries) react to changes in the USD exchange rate.Zhang, Fan, Tsai, and Wei (2008) documented a significant, long-term influence of the USDexchange rate on the international crude oil market, but found that any short-term andimmediate influences were quite limited. However, the Congress and the public started to worry when a trend depreciation ofthe dollar since 2002. The reason is the dollar’s decline is a symptom of broader economicproblems, such as a weak economic recovery, rising public debt, and a diminished standing inthe global economy. A depreciating currency will impact the U.S. economic performance.Possible effects include increased net exports, decreased international purchasing power,rising commodity prices, and upward pressure on interest rates; if the trend is sustained, theUnited states may also experience a reduction of external debt, possible undermining of thedollar’s reserve currency status, and an high risk of a dollar crisis. Therefore, the governmental policy is existing in order to response to this fluctuation ofU.S. dollar. Those governmental policy included the monetary policy actions by the FederalReserve, over which Congress has oversight responsibilities, can affect the dollar. But theexchange rate is not a variable that is easily addressed by changes in governmental policy.The exchange rate of the dollar is largely determined by the market which is the supply anddemand for dollars in global foreign exchange markets associated with the buying and sellingof dollar denominated goods, services, and assets (e.g., stocks, bonds, real property) on globalmarkets. In most circumstances, however, international asset-market transactions will tend tobe dominant, with the size and strength of inflows and outflows of capital ultimately determiningwhether the exchange rate appreciates or depreciates. This will cause the fluctuation in U.S.dollar. 7
  9. 9. The Federal Reserve actions are influence with the international economy. Forexample, if Federal Reserve actions raised US interest rates, there will be an increase in theforeign exchange value of the dollar, in turn would raise the price in foreign currency of USgoods traded on world markets and lower the dollar price of goods imported into the US. Theycould lower output and price level in the US economy by restraining exports and boostingimports. Moreover, the US monetary policy action has significant effects on growth andinflation in foreign economies. The Federal Reserve and other countries to maintain acontinuous dialogue enables the Federal Reserve to better understand and anticipateinfluences on the US economy and discuss topics of mutual beneficial. The purpose of FederalReserve foreign currency operations has evolved in response to changes in the internationalmonetary system, which from a system of fixed exchange rates to a system of flexibleexchange rates for the dollar in terms of other countries’ currencies. Under the flexibleexchange rates, the main aim of Federal Reserve foreign currency operation has been tocounter disorderly conditions in exchange markets. The effects of intervention on FederalReserve balance through open market operation could be offsets by the Federal Reserve. TheUS holdings of foreign exchange reserves is the main source of foreign currencies used in USintervention operations. The US monetary authorities have arranged swap facilities with foreignmonetary authorities to support foreign currency operations. The Federal Reserve plays afunction as bank supervisor in international banking institutions to help interpret US monetaryand credit conditions. The US dollar has been the dominant currency of the world economy and had been theworld reserve currency. There are approximately two third of the US currency accounted asofficial exchange reserves. In addition, more than four fifths of all foreign exchange transactionsand majority world exports are denominated in dollars, as well as IMF loans. The purpose ofintroduction the euro had for diversification into dollar for investors who had obtained portfoliobalance by holding European currencies. The stability between the exchange rate of the euroand the dollar has increased the value of the currencies and become more closely correlated.The European Union countries adopted the euro as their common currency which directlycompeting with the dollar. Start from 2002, the euro has gained widespread internationalacceptance resulting in important institutional, economic and financial markets for Euro zone,the US and the world economies. For example, the euro has been widely using in LatinAmerica, which the country reference currency is the US dollar. The flow of direct Europeaninvestment toward Latin America has reached the level comparable with the US. Moreover, 8
  10. 10. according to the Bank for International Settlement Russian banks, that have been significantlyincreasing their euro denominated debt and have continue to migrate from banks in the US tobanks resident in Europe. In the future, the euro might be playing an important role in theinternational market just like the US dollar. 5.0 DISCUSSION AND FINDINGS 5.1 The Factors That Influence the US DollarThe factors that directly affecting the U.S dollar are trade deficit versus the U.S. dollar index,Housing bubble, Size and liquidity of asset markets, Interest rates, currency pegs, marketpsychology, inflation, gold fundamentals. How the trade deficits versus the U.S. dollar index affect the U.S. dollar? Trade deficitreflect the excess spending in the domestic economy and reliance on capital imports to financethat shortfall. According to Nanto and Donelly (2011), The rising of the trade deficit withdownward pressure on the value of the dollar, which help to shrink the deficit by making theU.S exports cheaper and import more expensive. Increase in the trade deficit may diminisheconomic growth, this is due to the net exports are a component of gross domestic products.U.S trade and current account deficit might lead to large drop in the value of the U.S dollar. Ifthe foreign investors stop offsetting the deficit by buying dollar denominated assets, the valueof the dollar will drop too. The inflows of the capital to compensate U.S trade deficit and a lowU.S saving rate are help to maintain the value of the dollar. Next factor is the housing bubble. Housing bubble could be defined rapid speculationin house value until they reach unsustainable level relative to incomes or some other economicfundamentals. Mckibbin and Stoekel (2006) declared that the boom in the house prices wasdriven by historically low interest rate and lack of perceived returns on stock markets followingthe bust of stock market boom in 2000. Rising prices of the houses generated expectations ofrise in property value, fuelling the additional speculative demands because of the investor shiftpreferences from stocks to property. House price is affecting the U.S. economy. When theinvestment flow to offshore assets the capital movement generates change the current accountbalances, exports and imports, and real exchange rates. Housing price will cause the propertyof the consumers increase, hence the wealth will be increase and vice versa. So the housingbubble would directly influence the U.S. dollar. 9
  11. 11. Size and liquidity of U.S asset markets also is one of the factor influence the U.S.dollar. U.S has offered the variety of asset types and high degree of liquidity. U.S. treasurysecurities as the high liquidity assets have attractive the foreign investors in this recent years.Elwell (2012) stated that the highly liquid dollar assets has attract the foreign central bank,which rapidly increase their holding of foreign exchange reserves, a substantial portion of whichare thought to dollar assets. It could influence the U.S dollar to become more valuable becausethe highly liquid treasury securities. In addition, interest rate also influences the fluctuation of the U.S. dollar. The demandof the foreigners is strongly influenced by the expected return of assets. Atinc, Atinc andUwakonye (2011) stated that if the banks choose to use fed as source of monetary holdings,the cost of borrowing is determined by the discount rate. U.S fed lower the FED funds due toextreme weakness of the U.S. economy because U.S can’t afford to pay high real rate on itscurrency. Thus, it will lower real rate and weaken U.S dollar.The foreign investors have beenkeen to buy U.S. Treasury securities because they are considered a ‘safe’ investment. In orderto purchase Treasuries, foreign investors need to exchange their currency for U.S. dollars, thusincreasing demand for the U.S. dollar and causing it to appreciate or strengthen against otherworld currencies. According to Bedel (n.d.), when the interest rate earned on U.S. Treasuriesdeclines, the investment is less attractive to foreign investors and their money goes elsewhere,causing the dollar to weaken. Furthermore, currency peg also cause the fluctuation of the U.S. dollar. A currency pegis when one country fixes its currency against that of another country. This means that thepegged currency will rise and fall in line with the currency it’s pegged to. FT (2008) stated thatthe peg will happen because normally a weaker currency would peg itself to a stronger one. Byputting a peg in place a government deprives itself of the ability to interfere with domesticmonetary policy. Interest rates have to be set to maintain the fixed rate against the ‘peg’ and,like the currency, will likely reflect interest rate moves of whatever central bank controls the‘pegged to’ currency. This gives the reassurance of a commitment to price stability, which inturn should eventually allow lower interest rates and help the pegged currency to gain that all-important credibility. The stability of the currency will lead to dollars become stable. Next factor is the market psychology. Investors have expected the future path of thedollar. The expected dollar depreciation lowers the expected return and reduce theattractiveness of the dollar assets to the foreign investor while if the exchange rate is expected 10
  12. 12. to be appreciate, the expected gain will greater than nominal interest rate. The currency traderspeculative in nature and is designed to profit from short to medium term trends. It will maketrades in an anticipation of economic announcement such as GDP, inflation numbers and thecentral bank announcements. The other type is the traders make the technical analysis to thelook over the trends and the chart patterns to predict the movement. Following from that, theremay be a flight to quality in a particular currency as a result of worldwide economic stress. Inflation also would influence the U.S. dollar. Inflation erodes the purchasing power ofa particular currency and occurs when the growth in the money supply is higher than thegrowth in GDP. If GDP remains constant with a money supply that is increasing, consumer willneed more money purchase the same amount of goods, leading to higher prices and a weakercurrency. High nominal interest rates might not indicate a strong currency, as the inflation ratemay be high as well. The concept of purchasing power parity states that the cost of an identicalgood should be the same around the world. Thus, it will affect the U.S dollar. The last factor is the gold fundamentals. Gold have the close significant relationshipwith U.S. dollar. Responsible gold, org shows that a falling of the dollar increase the purchasingof the non dollar area countries and driving up price of the commodities including gold. Unlike acurrency, the value of gold cannot be affected by the economic policies of the issuing countryor undermined by inflation in that country. Gold also brings much needed diversity to a centralbank portfolio due to its low correlation with key currencies and its strong inverse correlationwith the US dollar. The gold can influence the U.S dollar. It would stabilize the U.S. dollar. 5.2 The US Dollar Fluctuation Affected the World EconomyThe United State economy and the world economy are linked in many ways such as foreigndirect investment, export and import, international banking transaction and so forth. And, theUS is a vital destination for exports from other economies. The US dollar is widely used ininternational transactions; therefore, the fluctuations in the US dollar have importantimplications for prospects for world economic growth. The gradually depreciation of the dollar against a number of currencies is useful andwould help in facilitating the rebalancing of the huge US current account deficit. US exportsbecome cheaper and increase in demand for US exports. In short, it is certainly a stimulus forUS exporters and will support expansionary fiscal and monetary policies to get the US 11
  13. 13. economy to faster growth. In addition, this would provide the much needed time for currentrecovery of strengthen domestic demand and broaden in the Asian and Western Europeaneconomies. However, the impact on various world economies would be different because undersuch international exchange rate changes. The competitiveness of US made products on worldmarkets would gradually increase and hence provide support for US economic activity.Nevertheless, a strengthening in the euro and the yen against the US dollar would restraingrowth in exports from Western Europe and Japan to the US, as well as to some othercountries, including China and Malaysia, that have their currencies pegged the US dollar. While the impact of a gradual decline in the value of the US dollar might be beneficialfor the world economy, a sharpen depreciation in the US currency would be destructive forworld economic growth, especially if it were to happen at the current stage of world economicrecovery. This is because of weak domestic demand in the Asian economies and a sharpdecline in their export performance could trigger a slump in consumer and business confidence,leading to a decline in domestic demand. The resulting would definitely lead to a significantlyweaker economic growth. A marked reduction of import demand due to US consumer find imports moreexpensive would have significant effects on the economic performance of its major tradingpartners. This could lead to lower growth in other countries especially those who rely onexports to US. For example, Canada and Mexico, both countries supply more than 80 percentof their export to the US. As well, the Japanese export sector would be adversely affected by a significantreduction in import demand in the US. Besides the direct effect through reduced export activity,there would be significant downside risks surrounding economic activity in Japan. Theweakening in Japan’s export performance could result in a marked increase in nonperformingloans and corporate bankruptcies. The adverse effects on consumer and business confidencecould lead to a more significant increase in unemployment and a sharper decline in consumerspending. Therefore, import demand could fall markedly, despite a significantly strongerJapanese yen against the US dollar. 12
  14. 14. Once the US dollar was to depreciate sharply, the export performance of WesternEurope would also be adversely affected. Western Europe is a major provider of capital to theUS, a reduction of capital inflows to the US means that capital outflows from Western Europewould decline too. The adverse effects of lower export performance on economic growth inWestern Europe would be largely offset by the benefits of a reduction of capital outflows fromthe region. After all, those whose currencies are tied or pegged to the US dollar with respect totransactions and upward or downward variations would tighten the weakening dollar. As far asthese countries are concerned, the depreciation dollar leads to rising inflation which expands atthe expense of the growth rates. Hence, as inflation increases, the nations are forced to doubletheir economic activity to maintain high growth rates. The list of emerging economies facing thisdifficulty includes China, Russia, India, and Arab. In these countries, as their currencies arepegged to the dollar and their economies rely on exports cause the inflation rapidly eats intothe public budgets heavily dependent oil revenues. Recently, China is the largest foreign holder of US treasuries which has support thevalue of the US dollar. China pegs its currency, the Yuan; lower than the US dollar to keep itsexport prices competitive. However, the downgrade of the US credit rating and the falling valueof US debt are bad news for China’s large holdings of foreign exchange assets which aredenominated in US dollar. As the US largest credit holder, China is aware of its possible losses.The debt crisis would result in a decline in demand in overseas markets and possibly affectingChina’s exports. According to Jierui (2011), Zhang Xiao Qiang, deputy head of National Developmentand Reform Commission stated, the US Federal Reserve’s policy of keeping interest ratesnearer zero until 2013 will lead to higher worldwide inflation, and higher commodity prices. Ifthe US continues its loose monetary policy, it will hurt the purchasing power of China’s foreignexchange reserve. Besides that, concerning with the depreciation of US dollar is stokinginflation in China; he also said that China is facing high unemployment, high inflation, and weakconsumption demand. This will definitely have a negative impact on China on its exports andcommodity prices. Briefly, the dollar’s depreciation against the world currencies and imposes aburden on the world economy. 13
  15. 15. The US dollar appreciated significantly against major international currencies between1997 and early 2002. On a trade weighted basis, there was around 30 percent of the value ofthe US dollar increased over this period. While, the US dollar appreciated would increase thepurchasing power of US consumers, and hence increase import demand. Higher importdemand in the United States will lead to improved export and hence economic performance inmany international economies especially those in Europe, Asia and Latin America. For example,if the dollar appreciates against the yen, then Japanese produces selling to US markets will findthat their dollar revenues translate into more yen than in the past. The strong capital inflowshave increased the spending capacity of US business and households. Thus, the importdemand in the US increase substantially has leading to the market widening of the tradeimbalance. 5.3 The Countries Have Been AffectedThe economy of the Middle East is very varied. The Middle East countries Bahrain, Cyprus,Egypt, Iran, Iraq, Jordan, Israel, Kuwait, Lebanon, Oman, the Palestinian territories, Qatar,Saudi Arabia, Syria, Turkey, United Arab Emirates, and Yemen are the individual economiesrange from hydrocarbon exporting renter economies to government led socialist economies tofree market economies. According to Canova and Ciccarelli (2011), most of the countries arebest known for producing and exporting oil. The wealth is generate and through the movementof the labour had significantly impact the entire region. For example, the Bahrain is the countrywhich owns largest oil deposit with small population per capita GDP of $27300. This state hadprolonged industrial capacity to refining capacity that outstrips its own oil production. TheseMiddle East countries are influenced by US dollar fluctuation. The economic conditions in the United States create a consistent demand for USDsand upward pressure on the USD’s value. This situation allows the US government gainrevenues through issuing bonds at lower interest rates. As a result the U.S. government ablerun higher budget deficits at more sustainable level compare to other countries. The strongerUSD will able make the imported goods into United States are relatively cheap. According to Coudert, Mignon and Penot (2008), the most oil sales especially in MiddleEast are dominated by United States dollar (USD). This fact had been supported by proponentof the petrodollar warfare hypothesis; because according to the hypothesis most countrieswhich are depend on oil imports had been forced to preserve large stockpiles of dollars in order 14
  16. 16. to continue their imports. These countries need to preserve large stockpiles of dollar becauseof the status of the United States dollar as the world’s dominant reserve currency and as thecurrency in which oil is priced. As oil trade from Middle East Countries such as Iraq, Iran, Saudi Arabia, United ArabEmirates, Libya, and Kuwait is dominated in US dollars, movement in the dollar effectiveexchange rate affect the price of oil as perceived by all countries outside the United States.Hence, change in the dollar exchange rate can cause changes in oil demand and supply,eventually changes in the oil price itself. Secondly, the reserve causality can also be found, aschanges in oil prices may well influence the effective exchange rate of the dollar. For example,in the model by Farugee (1985), the exchange rate will value if a country accumulates foreignassets, and this movement occur without looming its current account balance. It is because thecapital income takes over the lost in trade receipts induced by deteriorated competitiveness.Third, stock of portfolio model also will influenced by the US dollar fluctuation. According toAccording to Fezzani and Nartova (2011), there are designed to take account trade andfinancial interaction between United States, and Middle East countries. Coudert etc. (2008) declared that declared that the impact of US dollar effectiveexchange rate is seen on oil demand and supply, since it affects the price of oil which isproduced by Middle East countries. The oil was perceived by all customers and oil producersoutside of US. These effects depend on currency used in different transactions linked to oilactivities. Moreover, the US dollar fluctuation also effect on demand. The oil which has beenpurchased are paid using dollar. However, demand depend on the domestic price for consumercountries which usually change according to dollar fluctuation. Therefore, the dollardepreciation can reduce the oil price in domestic currency for countries with a floating currency.The dollar depreciation generally tends to decrease the oil price in consumer countries. Basedon this situation, it can lead to an increase in their real income and increase in their oil demand.Therefore, the dollar depreciation prior has a positive impact on oil demand and shouldcontribute to raise the price. On the other hand, Coudert etc. (2008) stated that the US dollar fluctuation also caneffect on supply of oil. Normally, the oil company use domestic currency of procedure countriesto pay their employees, taxes, and other cause which the currency are often linked to the dollarbecause of the fixed exchange rate regimes adapted by most producer countries. As aconsequence, dollar changes perhaps affect the price as perceived by the producer than the 15
  17. 17. one perceived by demanded. Generally, the dollar depreciation may result in a deduction in oilsupply. The dollar effective depreciation cause an increase in oil demand and the deduction insupply, mainly on the long run which tends to boost oil price. According to Coudert etc. (2008), the increase in oil price stems from to simultaneousfactors, first is strong surge badly anticipated of oil demand particularly in United States.Second is according to Jackson (2010), dwindling investment in the oil sector that lead tostagnation of production capacity. However, those demand and supply effects the dollardepreciation which associated to a drop in oil price, not raise. The dollar depreciation requiredto stabilize the US external position. However, it is not complete since it overlooks themultilateral natural of exchange rate. Besides that, dollar depreciation can also cause inflationand reduce the income in oil producer country because the currencies are linked to the dollar.The increase inflation and the decrease in purchasing power reduced the real disposableincome and therefore available for drilling, everything else equal. Countries like Japan and China are large purchasers of US debt. China in particularhas exhibited an insatiable appetite for US debt. Its rapidly growing economy is greatlydependent on exports, and the US is one of its largest trading partners. In any given year, theUS imports much more from China than it exports to China. As a result there is a net flow ofdollars to China. Normally, one might expect China to sell these dollars on the global market,causing the dollar to weaken. As an alternative China is reinvests its dollars in US debt. Indoing so, China strengthens the US dollar and limits the appreciation of its own currency. As aresult Chinese exports remain cheap to American consumers. However, due to large deficitsmany countries, China, Russia and India in particular, have begun to reconsider diversifyingtheir reserves to protect themselves from a devaluation of the US Dollar. The decision of theselarge countries to shift increasingly towards Gold as a reserve currency greatly decreases thedemand for US Dollars and weakens the USD. The Chinese currency is presently fixed to the value of the US Dollar, so as the valueof US Dollar changes on international currency market, the relationship between the ChineseRenminbi and the US Dollar remain the same. Some countries say that this does not give atrue indication of the strength of the Chinese currency internationally and there is pressure onChina to change the current relationship to the US Dollar. When the dollar declines, it makesU.S. produced goods cheaper and more competitive when compared to foreign producedgoods. This helps increase U.S. exports, boosting economic growth. However, it also leads to 16
  18. 18. higher oil prices in the summer, since oil is priced in dollars. Whenever the dollar declines, oilproducing countries raise the price of oil to maintain profit margins in their local currency. Thegrowing U.S. debt weighs in the back of the minds of foreign investors. That is why they maycontinue to gradually move out of dollar-denominated investments - slowly, so they do notdiminish the value of their existing holdings. The best protection for an individual investor is awell-diversified portfolio that includes foreign mutual funds. The political climate in Liberia is still not stable to the point to ensure that capital flightwill not lead to massive outflow of US currency in circulation. Political disharmony anddiscontent serves to reduce investor confidence and in turn creates artificial capital flighttendencies in the economy. The Liberian economy is currently too dependent on the US dollardenominated incomes of foreign aid workers and remittances from Liberian nationals fromoverseas as a proportion of GDP. During the civil war years, Liberia’s foreign reserve positionwas completely depleted. According to Donzo (2009), recent report places it somewherearound $50 million dollars and even this is too small an amount to support a full dollarizedLiberian economy, although Liberia has done quite well in recent three years to negotiate thecancellation of a large portion of its foreign debt. The export earning capacity is still weak andthere is still a trade deficit that will only become corrected when some of the newly-signedforeign investment contracts start to yield export earnings and boost the foreign exchangerevenues of the government. A return to the US dollar as the only legal tender means that thecountry’s central bank will continue to operate as a bank or non-issue. It would be even lesslimited than now to exercise its role as a central monetary authority. Besides that, allowing adual currency regime or semi-dollarization to exist now might offer some time to build theconfidence needed to strengthen the exchange rate and overtime if the economy andexchange rate becomes strong enough, perhaps an attempt could be made toward fulldollarization. However, this should be a political as much as an economic decision becauseshould the variables to support dollarization falters. Lastly, a national currency is not only themedium of exchange; it is also a symbol of sovereignty for many countries. It embodies a sinceof economic independence or of national identity. Japans economy is challenged by rising commodity prices; the country imports most ofits food and oil, and a shrinking labour pool, as its population ages. Japans worst challenge isa national debt that is twice as big as its annual economic output. Like the U.S, much ofJapans debt resulted from efforts to stimulate its economy out of a 20-year deflationary period 17
  19. 19. and recession. A recession in Japan could cause it to purchase less Treasury bonds at a timewhen the U.S. is issuing more bonds to finance the economic stimulus bill and bailouts. Lowerdemand and greater supply of Treasury bonds will cause yields to rise, thus raising interestrates, further depressing the housing market. The dollar exchange rate affects the output of the East Asian economies in both tradeand foreign direct investment. When the East Asian economies keep their exchange ratesstable against the U.S. dollar they must cope with extreme fluctuations of the dollar against theyen. During the crisis of 1997, the currencies of Indonesia, Korea, Malaysia, Philippines andThailand were attacked. They had to end their dollar pegs and allow their currencies todepreciate. Singapore and Taiwan also followed with currency depreciations. However, Olson(2007) claimed Japan’s currency depreciated by more than 30 % during the 1997-1998 timeperiod. This resulted in severe deflationary pressures on the dollar prices of goods andservices traded in the region. The wide fluctuations in the dollar rate over the last 20 years ormore have created and influenced a business cycle in the smaller East Asian economies(ASEAN4). The East Asian exchange rates are still susceptible to the fluctuating dollarexchange rate. There are positive effects when the yen appreciates. For example, Olson(2007) stated that the Japanese FDI increases and the other East Asian countries exportsbecome more competitive against Japan’s exports. However, when the yen depreciates againstthe dollar (1997-1998), their output decreases, FDI from Japan decreases and their exportsbecome less competitive. Ahmed (n.d.) claimed that the dollar fluctuation also gives an impact to India economy.The rate at which a currency can be exchanged is the rate at which one currency is sold to buyanother. India FX rate system was on the fixed rate model till the 90s, when it was switched tofloating rate model. Fixed FX rate is the rate fixed by the central bank against major worldcurrencies like US dollar, Euro, and GBP. Like 1USD equal to Rs. 40. Floating FX rate is therate determined by market forces based on demand and supply of a currency. If supplyexceeds demand of a currency its value decreases, as is happening in the case of the USdollar against the rupee, since there is huge inflow of foreign capital into India in US dollar.Indian rupee appreciation against dollar impacted heavily to the exporters. Exports from Indiaare of handicrafts, gems, jewellery, textiles, ready-made garments, industrial machinery,leather products, chemicals and related products. Since the 1990s, India is the world’s largestprocessor of diamonds. The mentioned export items contribute substantially to foreign receipts. 18
  20. 20. Imports to India are of petroleum products, capital goods, chemicals, dyes, plastics,pharmaceuticals, iron and steel, uncut precious stones, fertilizers, pulp paper so on. This gainon FX is likely to create savings in cost, which could be passed on to consumers; therebycontributing to control inflation Foreign investment into India is also contributing well to dollardepreciation against dollar. With the recent liberalized norms on foreign investment policy likeForeign investment of up to 51% equity limit in high priority industries, foreigners and NRIs areallowed to repatriate their profits and capital with exception for Indian nationals who wereallowed to do so only under special circumstance and allowing free usage of export earnings toexporters, made foreign investment in India very attractive. It is this favourable atmospherewhich made FX reserve surplus in US dollar and helped rupee to appreciate. Arieff, Weiss, and Jones (2009) said that the value of total U.S trade with Africa hadincreased by about 29% between the year of 2007 and 2008. After the continuous growthwithin the three years the value of Africa’s exports to United States decreased in value byabout 57% in the first six months of 2009. U.S exports to Africa decreased in value by about9%. The decline in value of U.S imports from Africa largely reflects the decline in oil price fromlate 2008 through early 2009, as oil and mineral fuel account for about 80% of all U.S importsfrom Africa, and 92% of all U.S. import. Petroleum imports did not decrease in volume asdramatically as they did in value, however the decrease in U.S. and global consumption arelikely to continue to have a negative effect on most export from the region. According to Bower,Geis, and Winkler (2007), commodities had play an important role in the economies of most the24 countries in Western and Central Africa (WCA), which derive the majority of theirmerchandise export revenues from one single commodity or several commodities. Most WCAeconomies developed positively between 1999 and 2005, although differences between net oil-exporting and importing countries were clear. Net oil exporters recorded the highest growthrates, mainly supported by rising investment and exports on the back of record oil prices andexpanding oil in some countries. Rising oil prices make burden on WCA economies, whichoften counteracting benefits accruing from rising prices for their own main export products. 5.4 Policy to ResponseSince 1973, Bretton Woods fixed exchange rate international monetary system failed toexecute successfully, the de facto U.S. dollar policy has took over the role to determine thedollar’s value. According to Elwell (2012), Treasury Secretaries claim that United States has astrong dollar policy but have rarely taken direct steps to influence the dollar’s value. 19
  21. 21. The demand and supply of dollar assets will have the greatest direct impact on thedollar fluctuation. The policy that has taken by the U.S. government against the fluctuation ofdollar is government direct intervention in the Foreign Exchange Market. This policyinvolves the Federal Reserve at the request of the Treasury buying or selling foreign exchangein order to influence the dollar’s exchange rate. To strengthen the dollar, the Fed could attemptto boost the demand for dollars by selling some portion of its foreign exchange reserves inexchange for dollars. However, the scale of the Fed’s foreign exchange holdings is smallrelative to the size of global foreign exchange markets, which have a daily turnover of morethan $4.0 trillion. In this case, the Fed will inadequate to counter a strong market trend awayfrom dollar assets and prevent depreciation of the dollar. Following from that, there is acoordinated intervention by the Fed and other central banks. This would have a greater chanceof success because it can increase the scale of the intervention and have a stronger influenceon market expectations. For example, the Plaza Accord of 1985 to weaken the dollar, theLouvre Accord of 1987 to stop the dollar’s fall, joint actions with Japan in 1995 and 1998 tostabilize the yen/dollar exchange rate, G-7 action in 2000 to support the newly introduced euro,and G-7 action in 2011 to limit appreciation of the Japanese yen. The next policy in response to the fluctuation of the U.S. dollar fluctuation is themonetary policy. Changing the level of interest rates can also influence the U.S. dollar. Atighter monetary policy would tend to strengthen the dollar because higher interest rates, bymaking dollar assets more attractive to foreign investors, other things equal, boosts thedemand for the dollar in the foreign exchange market. In contrast, lower interest rates wouldtend to weaken the dollar by reducing the attractiveness of dollar assets. However, in thecurrent macroeconomic situation, if the Fed intended to prevent the dollar from depreciating, itwould be constrained from applying the monetary stimulus in order to promote economicrecovery. Currently, the Fed’s policy of monetary stimulus is keeping interest rates low, andexerts downward pressure on the dollar as well. Other than that, the fiscal policy and Federal debt will also impact the U.S. dollar.Government’s spending and taxing will influence the exchange rate. Budget deficits tend tohave a simulative effect on the economy. Yet, because the government must borrow funds tofinance a budget deficit, it increases the demand for credit market funds, which, other thingsequal, tends to increase interest rates. Higher interest rates will tend to increase the foreigndemand for dollar-denominated assets, increase the exchange rate. However, in the current 20
  22. 22. state of the U.S. economy, with a sizable amount of economic loose and weaker than normalprivate demand for credit market funds, current government borrowing does not appear to havehigh market interest rates, and therefore does not able to rise the exchange rate. Theseconditions will continue to slow down the raising of interest for currently anticipated governmentborrowing and continue to exert minimal upward pressure on the dollar. After all, as economicrecovery move the U.S. economy closer to full employment and the private demand for creditmarket funds increases, continuing large government budget deficits may result in higherinterest rates. Some foreign investors could be attracted by these higher interest rates,increasing their demand for dollar assets. This would exert upward pressure on the dollar. Policies that tend to increase the foreign demand for U.S. goods and services alsotend to strengthen the dollar. The policy of lower foreign trade barriers will tend to impact theU.S. dollar. The continued existence of various trade barriers in many countries may keep thedemand for U.S. exports weaker than it otherwise would be. The lowering those barrierssignificantly will boost the demand for U.S. goods and services; it would also exert someupward pressure on the dollar exchange rate. 6.0 CONCLUSIONConclusively, depreciation of U.S dollar value has greatly influences on the U.S economy ingeneral and other countries as well either it are detrimental or beneficial impact. It depends onthe country how to make use of the fluctuation of U.S dollar and turn it to advantage to itseconomy. The accumulative of factors which include trade deficit versus the U.S dollar index,housing bubble, size and liquidity of asset markets, interest rates, currency pegs, marketpsychology, inflation, and gold fundamentals has cause the fluctuation of U.S dollar over theyears. Since of the high level of international economic combination, or trade betweendifferent countries, U.S dollar are sure affected by many things. This means that U.S and othercountries’ policies and economies circumstances have an impact on the fluctuation of the U.Sdollar. Depreciation of U.S dollar overall makes the U.S manufacturers happy, since exportsmade with cheaper dollars can be sold to overseas for more profit. However, the Asianeconomies are suffering from weaker economic growth and sharp decline of their exportactivities because of the fluctuation of U.S dollars. 21
  23. 23. United State government had taken a few policies to constrict the fluctuation of dollar.The U.S Treasury and Federal Reserve often synchronize policies that affect dollar exchangerate. One of the policies is government direct intervention in the Foreign Exchange Market.Secondly is monetary policy. To strengthen the U.S dollar, it has to tighten the monetary policy.Moreover, fiscal policy and Federal debt are one of the policies. Government’s spending, taxingand budget deficit will influence on the economy. Lastly is a lowering foreign trade barrier willincrease the demand for the U.S goods and services. To have deal with the fluctuation of the U.S dollars, there is way that is Eurodollar.Euro could be merging with the dollar and would act as a single currency for United States andEurope. This might decrease the fluctuation of U.S dollar. Eurodollar would produce economicbenefits. Eurodollar as single currency makes economic transactions easier than havingdifferent currencies for the union. Investors who want to invest in foreign country can save theirtransaction cost because they do not have to convert money from one currency to another.Moreover, Eurodollar would support international trade and lessen the disruptions that resultfrom the currency fluctuations. 22
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