The dollar has depreciated against other major currencies. After the Federal Reserve announced the reduction in interest rates, the dollar fell even further, to a level not seen since 1997. The falling dollar could be an outcome of trade account and current account deficits run by the US in the past. Since then, from its peak in 2002 and October 2007, the dollar has fallen approximately 28% in nominal terms and about 25% in real-terms. A weak dollar is not a novel concern.
Between early March and mid-May 2007, a depreciation of the US dollar was clearly a significant contributor to the 7.4% appreciation of the Canadian dollar, from 84.7 cents to 91.0 cents. At the same time, the euro gained 3.5% over the US dollar and the British pound gained just under 3.0%, but the yen lost a bit. Nevertheless, these major currencies averaged almost a 3.0% gain over the US dollar. So, about 40% (3.0/7.4 = 40%) of the gain in the value of the Canadian dollar relative to the US dollar over this period can be attributed to a decline in the value of the US dollar relative to major currencies.
This gradual decline of the US dollar could lead to the discarding of huge dollar reserves held by countries worldwide. In addition to this, the risk of US recession or other factors that could also cause a loss of confidence in the dollar, pose major risks to this scenario. A dollar crisis will be very damaging for the global economy, making the expected slowdown much deeper and long-lasting.
The US government has been running huge fiscal deficit and capital account deficit. These deficits are mainly financed by inflows of forex reserve maintained by other countries. In the view of many analysts and policymakers, dollar depreciation remains a key mechanism for addressing this export-import imbalance and restoring the international competitiveness of American producers.
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