By David Cho
Washington Post Staff Writer
Wednesday, September 26, 2007

So it has come to this for the tumbling U.S. dollar: It dropped below the Canadian dollar last week and is barely hanging on to parity now.

Along the northern border, shopping patterns are reversing. Instead of Americans driving north to get cheap medicine and other goods, Canadians are traveling south for better deals. A ticket for the Maid of the Mist cruise at Niagara Falls still costs $14 in Ontario and $11.50 on the New York side, but with the currencies virtually equal, the New York ticket is a bargain.

"It's a good feeling," said Canadian Tim Ruddy, the tour company's vice president of marketing. "There's a lot of pride that our dollar is strong. We're so used to being on the short end."

After sinking steadily for most of the year, the U.S. greenback hit a record low against the euro and declined against the yen yesterday. But nothing hits closer to home, literally, than seeing it fall to a 31-year low against the Canadian loonie, so nicknamed for the bird pictured on its coin.

The dollar's slide is affecting every corner of American life, from corporate earnings to vacation plans. But more disturbingly, it also has the potential to punish the very mortgage holders that the Federal Reserve intended to help with its aggressive interest rate cut last week.

That is because a low-value dollar makes long-term Treasurys less attractive, and new data from the Treasury Department indicate that China and other big investors in these bonds are beginning to sell their holdings. That helped send the 10-year Treasury price down and its interest rate up in the last week. Mortgages -- particularly jumbo and adjustable-rate loans -- are tied to this rate.

Richard Yamarone, chief economist at Argus Research, calls it "the Bernanke conundrum" -- a reference to a quote by former Fed chairman Alan Greenspan. When he raised interest rates earlier in the decade, longer-term yields went down, and Greenspan told a Senate committee it was a "conundrum." Now, a similar trend may be developing in the opposite direction on Chairman Ben S. Bernanke's watch.

"Bernanke lowers rates last Tuesday, but longer-term rates have gone higher, which . . . crushes mortgages because mortgages are linked to the longer-term rates," Yamarone said.

This time, Americans can't "blame Canada" for their woes -- as the Academy Award-nominated song from the "South Park" movie tried to do. Canada's economy is strong because of its oil production, and its real estate market is in fine shape.

The U.S. housing market, on the other hand, is a mess. Record mortgage defaults spooked debt investors from backing all types of loans. The resulting credit market freeze-up may have forced the Fed to lower interest rates before its governors wanted to do so, said several analysts who closely watch the agency.

"Bernanke had to do what he had to do," said Ashraf Laidi, chief foreign exchange strategist in the United States for CMC Markets. "But the U.S. dollar is really being damaged . . . and future homeowners could be hurt. It is a big significant negative for the housing question."

The Fed lowers interest rates to stimulate economic growth. But it does so by increasing the supply of money, which lowers the value of the dollar and can lead to inflation. Central banks must walk a careful line between these two outcomes.

In a notable departure from the Fed, the European Central Bank decided this month to focus on inflation and did not change its rates. That has helped keep the euro high and has also contributed to the fall of the dollar. It is highly unusual for Europe not to have followed a rate cut in the United States, Laidi said.

The Fed's rate cut and the drop in the dollar's value are rippling through the U.S. economy.

The stock markets soar on the expectation of higher economic growth and lending activity. U.S. tourism expects to get a boost as vacations overseas become more expensive. Big conglomerates such as Boeing, McDonald's and Coca-Cola earn more profit from their overseas divisions because foreign currencies are worth more when converted into dollars.

"When the dollar is weak, it increases the attractiveness of U.S. goods, keeps demand in U.S. domestic industries high, which benefits U.S. companies and jobs," said Kathy Lien, chief currency strategist at DailyFX.com.

But the prices of many commodities increase because it takes more dollars to buy copper, gold and oil on world markets. That, in turn, can raise the fuel costs or the expense of making consumer goods such as jewelry and bathroom fixtures.

It doesn't take a college degree to understand how these forces can affect daily life, Lien said. In the 1980s, she recalled, American children living near the border used to cross into Canada and exchange a U.S. dollar for five Canadian quarters, which at the time worked in vending machines and arcade games in the United States.

"It's extremely, extremely significant for the dollar to fall this much," Lien said. "Canadians now are turning the tables on us. Maybe some day they'll come down to our country and exchange their dollars for our quarters."