What's behind the dollar's decline in value?

Los Angeles Times Staff Writer

The dollar has lost a big chunk of its global purchasing power since the end of 2001 -- an average of 37%, as measured by one index that tracks the greenback against other major currencies.

Gauging the decline is easy; explaining why the buck has slumped is much more complicated.

Some theories about the dollar's fall are grand in scale: for example, the concept that the buck's fate is a symptom of a fading U.S. empire.

Other explanations are largely technical, including the idea that currency values are cyclical, and that the dollar's downswing inevitably will give way to an upswing.

On some level, the dollar's shift has to be about basic supply and demand. The price of anything usually will decline if there is an excess of it in the marketplace.

That's how Michael Woolfolk, veteran currency strategist at Bank of New York Mellon Corp., frames the buck's slide. He sees it as "the unintended result of globalization."

The boom in the developing world occurred in large part to supply the goods U.S. consumers wanted at low prices. As a nation, we borrowed heavily in the last decade to sustain our lifestyles, and sent trillions of dollars abroad to pay for imports, including oil.

The cumulative U.S. trade deficit -- the amount by which imports exceeded exports -- was a whopping $4.4 trillion from 2000 through 2007.

With the world awash in dollars, they've lost a portion of their value. And cachet.

Tom Higgins, chief economist at L.A. investment firm Payden & Rygel, says another factor helped wallop the dollar in 2007: the deep interest rate cuts by the Federal Reserve, intended to cushion the U.S. economy from the housing crash.

Low rates here compared with rates in most of the world made U.S. bonds less appealing to global investors. As they pumped cash into non-U.S. bonds, investors helped boost the value of the currencies in which those bonds were denominated, at the dollar's expense.

But Higgins and Woolfolk both note that, left to their own devices, free markets eventually should correct their own imbalances. As the weak dollar boosted prices of imports while lowering the prices of American exports for foreigners, the U.S. trade deficit fell last year for the first time since 2001.

If the U.S. economy comes out of its funk in the next year or two, the inherent investment appeal of American assets to foreigners should help bolster the dollar, Woolfolk maintains.

And despite the popular notion that the world might abandon the dollar as the primary global currency, Higgins says that isn't realistic -- because, as he puts it, "there's really nothing to replace the dollar."

He also points out the need to keep history in mind when discussing currencies' shifts: "The dollar has gone through long periods of strength and then long periods of weakness."

The slide of the last 6 1/2 years, Higgins notes, followed seven years of a rising dollar, from 1995 through 2001.

So this cycle, he said, could well be about to turn.

tom.petruno@latimes.com

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