On Tuesday the Fed Chairman Ben Bernanke ended weeks of speculation when he finally cut interest rates by an unexpectedly bold 50 basis points.The dollar immediately fell against all major currencies.It fell to almost 1.40 against the euro and to just over 114 against the Japanese yen.Experts expect the dollar to continue its slide against major currencies unless various central banks also cut interest rates to maintain the existing parity with US interest rates.
The debate over whether a weak dollar is good or bad for the US is endless.The advantages of a strong dollar are that it makes imports cheaper which in turn keeps inflation in check.US consumers also benefit when they either travel abroad or invest in foreign markets as the dollar simply buys more.The flip side is that US companies have to compete with cheaper imports or foreign goods in overseas markets.Foreign tourists do not find the US to be an attractive destination and foreign investors are reluctant to invest in the US.Exactly the reverse happens when the dollar starts to weaken.Then again it is not necessary that a weak dollar impacts everybody the same way.Some companies which are large exporters stand to gain whereas companies which are large importers stand to lose.Further the dollar may weaken to a larger extent against one currency, say the euro and to a lesser extent another for instance the Chinese yuan.Suffice it to say that foreign exchange movements in modern times are far more complex than at any time in the past and whether a weak currency or a strong currency is good or bad also depends on the view one may take of the matter.
The present cut has been forced upon the Fed by the collapse in the housing market and the sub prime crisis.Experts believe that this was perhaps the only way to avoid a recession.But now there is a growing fear that foreign investors will start avoiding the US bond markets.Data already suggests that in July there have been net sales of US treasuries with sales falling to $19 billion from about $97 billion.As the yield gap between the US and the rest of the world narrows this trend may accelerate leaving the US to find other ways of financing its current account deficit which is expected to rise to $850 billion or 6.5% of GDP this year.Foreigners have funded 25 to 30% of US credit and short term paper markets over the last two years.The sudden fall in the dollar's value may also reverse money flows back into Japan causing further pressure on the dollar.Long term bond yields in the US would rise, "increasing mortgage rates" and aggravate the housing crisis rather than solve it.
As other countries hesitate to cut interest rates in step with the US for fear of kindling inflation it remains to be seen whether the dollar is going to fall dramatically against other major currencies or not.Bernanke may have gambled by cutting aggressively as a rapidly weakening dollar is clearly not in any body's interest.