Falling dollar saga still has a long way to go

Richard Nixon’s Treasury secretary, John Connally, famously remarked that “the dollar is our currency, but your problem”. He would be right again now. The rest of the world normally wants a strong dollar. Yet the dollar is now in a bear market. How long might this go on? The plausible answer must be: a while yet. Since early 2002 the dollar has been on a steep downward path: on JPMorgan’s trade-weighted real exchange rate it has depreciated by 23 per cent since February 2002. This is the third such sustained decline since Mr Connally’s remarks. The first was during the early 1970s. The second was from 1985 to 1988. On each of the two previous occasions, the depreciating real exchange rate also helped generate a big adjustment in the balance of payments. This was strikingly true in the 1980s. The same thing is happening again. Between 1996 and 2004, real US domestic demand grew faster than real gross domestic product every year. This was necessary, I have previously argued, if GDP was to rise in line with potential, given the prevailing real exchange rates and the weak rate of growth of demand in much of the rest of the world. Over these years, cumulative growth in US real demand was 39 per cent, while GDP grew by 33 per cent. The difference was the real increase in the deficit in trade in goods and non-factor services. The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free – click ‘Comments’ below

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