Summary: Reuters reported that the dollar took a hit today that rang through the stock markets sending all of the major averages down today worldwide. U.S. stocks sank after a call from the world’s richest nations, the G7, for more flexible exchange rates sparked a sharp drop in the dollar that ignited fears overseas investors would flee U.S. assets. They said a flexible currency rate “is desirable for major countries or economic areas” in order to iron out global economic imbalances.” This signaled that Japan would interfere less with the value of the yen against the dollar. For some time, they have been intervening to hold the yen down so the US would continue to buy their imports. The weak dollar will benefit US manufacturing as our goods will be less expensive to foreign customers. This also extends to China who fixes their currency, the Yuan, to the dollar. Flexibility will allow the dollar to fall against the Yuan to a more reasonable level.

My Take: The impact of the strength of the dollar is both psychological and real. There are so many that feel that the traditional strong dollar policy has something to do with a strong nation and without any economic knowledge would think less of an administration that would support a “strong” dollar policy. Hence from this perspective strong vs weak is not the typical definition as construed by the voters and we often bow to political pressure when it is clearly wrong. But there is a real concern about the weakness of the dollar and its affect on interest rates, which is our topic this week. If foreign investors feel that the dollar will continue to fall, they may elect to remove their investments from the US and therefore sell US treasuries. Selling a bond lowers the price and raises the interest rates. If China or Japan, who both have billions in US treasury bonds, start to sell, rates could rise, possibly substantially. If professional investors feel that those nations may be making a move, they may try to profit from this by selling dollars and buying Yen, sending it down further or just moving their current dollar denominated investments to Eurodollars or other currencies that will appreciate when the dollar falls. Viewing the situation as only a gain for US manufacturing and not a threat to our economic recovery is short sighted and biased.