When the world is in turmoil, investors have usually had one automatic response: Put money into dollars, viewed as the global safe harbor.
But that’s not happening in this tumultuous year. Even with the Middle East in conflict, Japan in disarray after a series of disasters and Europe facing a debt crisis, the dollar has been gradually falling in value against other major currencies. Having fallen relative to the euro, pound and yen in recent months, the dollar is down 7 percent against a basket of six major currencies since Jan. 7 and 14 percent since June.
The decline in the past few months has been driven by a sense that the Federal Reserve will keep interest rates lower for longer than its counterparts overseas, and by a dissipation of the fears that drove the dollar sharply higher during the financial crisis of 2008 and 2009.
But the fact that the shift has occurred even as the world looks more dangerous shows that the dollar has lost some of its sparkle, suggesting the day may come when the dollar is no longer the place investors turn in times of trouble. That could have big implications for the economy in the years ahead.
In the short run, the cheaper dollar creates winners and losers in the U.S. economy. Companies that export — and the workers they employ — are more competitive. But the drop in the dollar also makes it more expensive to buy a gallon of gasoline, a Japanese television or a European vacation.
In the longer run, a declining dollar carries risks. The U.S. economy is fueled by the availability of cheap money from abroad. The fact that savers from Beijing to Buenos Aires look to the United States — and hence assets counted in dollars — as a place to save is a major reason interest rates here are among the lowest in the world, despite high debt levels.
As the euro and other currencies emerge as stronger alternatives to the dollar — and as the United States maintains easy-money monetary policies and high federal budget deficits — the chances of such a shift will increase.
“The dollar is still dominant, but as the European economy comes back and they are ahead of us in getting their fiscal house in order, that could set up the long-feared substantial move from dollar to euro as the dominant global currency,” said Fred Bergsten, director of the Peterson Institute for International Economics.
The good news is that the decline in the dollar has been orderly in recent months, driven not by fearful global investors dumping dollars but by those global investors gradually becoming more confident in the euro, the pound, the Canadian dollar and other alternatives.
It has happened despite the fact that the U.S. economic recovery has become more solid since the summer and that the European debt crisis remains unresolved. Just Wednesday, the Portuguese prime minister lost a parliamentary vote for major budget cuts to try to address his nation’s huge shortfall. But after falling initially, the value of the euro rose 0.6 percent relative to the dollar. Investors seem to have confidence that, one way or another, European officials will succeed in keeping the continent’s economy on track.
Higher interest rates in a country tend to increase the value of its currency because global investors can earn a higher return there. That gives central bankers, who usually control short-term interest rates as their major tool for setting monetary policy, some responsibility for fluctuations.
The Fed has repeatedly pledged to keep its target for short-term interest rates near zero for an “extended period.” The European Central Bank, by contrast, has signaled it will increase its interest rate target in May, aiming to combat higher prices for oil and other commodities.
“The ECB has sent clear signals that come hell or high water that they intend to raise interest rates,” Bergsten said. “And in the short run, it’s changes in interest rate differentials that drive exchange rates above all else.”
Similarly, the Bank of England is facing inflation levels higher than the bank targets. On Thursday, its chief economist said in a speech that it would make sense to take away some of the extraordinary measures the bank had put in place to stimulate growth.
“With growth expected to be around its average historical rate, inflation likely to remain above 4 percent for the rest of this year and [target interest rates] at record low levels, some withdrawal of policy seems sensible,” Spencer Dale said in a speech in London.
In Japan, the earthquake two weeks ago would normally be expected to cause the yen to weaken against the dollar. The reverse happened; the yen rose for five consecutive days after the earthquake, on expectations that Japanese firms would bring money back from abroad to pay for rebuilding — and perhaps some speculation. It ended when the world’s leading finance ministers and central bankers agreed to a rare coordinated intervention in currency markets to try to reverse the trend.