A weak dollar has coincided with a narrowing American trade deficit but relying on exports to salvage the economy may prove challenging.
With the dollar having fallen 24% against the euro over the five years to August, there were signs the American economy would be able to better weather the global slowdown. This was despite crashing house prices and weakening domestic consumer spending.
Since then the global contagion in the financial markets and the weakening of global economic forecasts saw the dollar rally relative to the euro.
The weakness of the dollar in the first half of the year helped to narrow the trade deficit by 4.1% in June putting it at $56.8 billion as exports to Britain, Germany and Italy all grew substantially.
However, as consumer and export demand weakened in the eurozone the currency reached a 12-month high of almost 1.60 in July the euro/dollar exchange rate has now fallen to 1.35.
“We were positive the dollar in the summer on the back of the US economy’s relatively strong position over the eurozone,” says Thanos Papasavvas, the head of Investec Asset Management’s currency management team. “This is part of the reason why the dollar started to strengthen in August and September.”
This first rally against the euro was deepened following the collapse of Lehman Brothers, formerly America’s fourth largest investment bank, as investors rushed into low yielding haven currencies.
As volatility in global markets is set to continue America’s competitive edge will be eroded still further, which threatens to undermine its short-term recovery prospects.
“If domestic demand isn’t supportive of GDP growth they might want to change policy and try to export their way out of trouble,” says Papasavvas (pictured).
“This would mean following a policy of benign neglect of the dollar, as they did between 2001 to 2006, but I’m not sure it will be politically easy.”
Any attempt to increase America’s share of the global export market is likely to meet resistance from Asian countries that rely on export income.
Papasavvas is positive on sterling against the euro as he says British monetary policy is able to be more timely in its response to an economic slowdown.