Rabobank Group

2-4-2008 | Other news

Rabobank's Chief Economist Wim Boonstra has published numerous articles on banking, financial markets, international economics and business cycles. In this column, Boonstra shares his views on today's current weakness of the American dollar.

Early in 2002, the Euro was at its all-time low against the US dollar.  Many economists expected a further fall of the euro. They were wrong.  It became clear that the fundamental value of the euro was much higher than the 80 dollar cent at which the markets were valuing it at the time. The ‘fundamentalists’ were right.  Since then the dollar has lost about 50% of its value against the euro.

Today, it seems like the same situation but with the currencies reversed. The US looks cheap when compared to Europe and many analysts argue that the US currency is undervalued today. They point at the fundamental value, measured by the so-called purchasing power parity (PPP). Analysts forecast a dollar recovery once the credit crisis is over.

In 2002, I was one of the believers in the fundamentals, but this time I am not so sure. PPP doesn’t tell the full story.  It appears in my viewpoint that the trouble for the dollar isn’t over yet. What is the core of the problem?  For decades, the US has been consuming more than is produced. The then special status of the dollar as the world’s anchor currency made this possible. In economics terminology, the famous ‘exorbitant privilege’ envied by so many European politicians in the past. The principle held that as long as the world is prepared to accept a growing amount of US dollars, the US can continue to produce external deficits. 

But the privilege appears to have been oversubscribed. The dollar is losing its special status at record speed.  Historically in times of dollar crises, the privilege meant that politicians from abroad had to deal with the internal money market problems themselves. Today’s current weakness of the US dollar has cost the rest of the world so far more than the value of USD 1,000 billion. This figure dwarfs all losses from the credit crisis.  
  
We are approaching the end of an era. At short notice, the dollar may show a cyclical recovery. The longevity of this is questionable. European exporters and politicians need to brace themselves for a two-dollar euro. Maybe not this year or next, but it may come sooner than most people think. 

Dr. Wim Boonstra, Chief Economist Rabobank Group