How Far Has the Dollar Fallen? And Why? — What’s Next?

Kurt Brouwer June 9th, 2008


As you know, the dollar has been falling against the Euro for several years. But, when you hear that the dollar has fallen to historic lows versus the Euro for example, it is sometimes hard to put that in an actual historic perspective. Also, for most Americans, it’s hard to understand why the dollar is falling. With this post, the goal is to give you the best answers available on both questions — How far has the dollar fallen? And why is it falling? We also want to look ahead as well.

Let’s start with how far the dollar has fallen. One problem with our media is that the news of the day is often one-sided and it seldom comes with any historical perspective. For example, do you remember hearing that the Euro fell to historic lows versus the dollar? Well, as you will see from the chart below, it happened not too long ago. In fact, the Euro fell steadily versus the dollar for the first five years of its existence, beginning in January 1999. It did not get back to even until mid-November, 2003. At the low point for the Euro you could have bought one for 84 cents. Now, it takes a $1.56.

Here is a chart showing the fluctuations of the Euro versus the dollar since inception in 1999. This shows how many dollars it takes to buy one Euro. When the blue line is heading down, the dollar is getting stronger. When the line heads up, the dollar is getting weaker.

U.S. Dollar / Euro

stlouisfed-dollar-euro-5-08-600-researchstlouisfedorg.PNG

Source: St. Louis Federal Reserve Bank

The gray bar in the charts indicates the relatively brief recession we experienced in 2001. You might notice that the recession coincided with the low point for the Euro (or conversely, the strongest point for the dollar during this time period). In other words, the very strong dollar and the recession went hand in hand because the Federal Reserve raised interest rates beginning in 1999 and that led to the recession. Higher rates cause the dollar to strengthen, but they also inevitably slow down the economy. On the other hand, lower interest rates are positive for the economy, but often not for the dollar.

Now, our economy has been strong for over five years and the dollar has fallen, more or less continuously during this economic upturn. Coincidence? No. Here is a chart showing the Federal Funds target rate for the same period.

Federal Funds Rate

stlouisfed-fed-funds-5-08-600-researchstlouisfedorg.PNG

Source: St. Louis Federal Reserve Bank

As you can see from the second chart, the Federal Reserve began raising interest rates to slow down the technology bubble in 1999. As seen on the top chart, when U.S. interest rates went up, the dollar rose versus the Euro. When the economy fell into recession in 2001 (the area in gray), the Fed began slashing interest rates and the Euro finally began strengthening versus the dollar. The Fed began raising rates again in 2004 due to inflation concerns and the Euro stabilized versus the dollar until the Fed stopped raising rates in 2006. At that point, the Euro began climbing and the process accelerated when U.S interest rates were cut in 2007 as the economy began to weaken.

What’s Next?

The big difficulty we face now is that the economy is weak and the Fed would like to cut interest rates or at least maintain them at a low level. The Fed cuts rates when it is concerned with economic weakness. As we have seen, lower interest rates helps the economy, but lower rates generally hurt the dollar versus the Euro. Due to weakness in the dollar, the response would ideally be to raise interest rates to help strengthen it. Inflation is also picking up steam and the normal response to that would be to raise short-term interest rates. Obviously, we cannot both raise and lower interest rates, so the Fed is hampered in its ability to respond to this situation.

In my opinion, this is not the fault of current Fed Chairman, Ben Bernanke, but instead the roots of this problem date back to the previous chairman, Alan Greenspan, who maintained very low interest rates for too long after the recession of 2001 and the terror attacks of 9-11.

The Fed’s current posture is that we should not expect any additional cuts to the Fed Funds rate. And, in all likelihood, we will see higher Fed Funds rates late this year or early next year as the economy begins to pick up steam. As a result, the dollar has shown a little strength lately. So the dollar should stabilize roughly around this level or a bit higher for a while and then we should see some strengthening when interest rates begin moving up (see Is the Euro Headed For a Fall?).

To put this entire discussion of the decline of the dollar in perspective, let’s look at one additional chart of the dollar versus another currency, the British pound sterling.

U.S. Dollar / British Pound

stlfed-uk-us-71-08-600-researchstlouisfedorg.PNG

Source: St. Louis Federal Reserve Bank

This chart shows that in 1972 it took over 2.5 dollars to buy one pound. The dollar then strengthened versus the pound and this process ended in 1985 when it took only $1.10 to buy a pound. Since 1985, the pound has generally strengthened versus the dollar. That is, for the past 23 years the dollar has generally fallen versus the pound. Yet, even at the recent peak of strength for the pound — October 2007 — the pound has still not made it back to the high point it reached versus the dollar back in 1972.

In short, major currencies fluctuate against each other daily, but the overall trends cover very long periods of time. If you look at the dollar/pound comparison over a shorter period, then you see the dollar is weakening. But, if you look over the longer period shown in the chart, then you see the pound on a long-term downward trend versus the dollar.

I hope this clears up some of the confusion and also allays some of your concerns. The dollar has always fluctuated against other currencies and this is nothing new. We have some work ahead of us to deal with the contradictory implications of a sluggish economy plus resurgent inflation and a weak dollar. However, this too is nothing particularly new.

Double Digits in 1980-82: Inflation, Unemployment & Mortgage Rates

I remember the great difficulties we faced in the late 1970s and early 1980s. We had sky-high inflation, unemployment and mortgages rates. At that time, the Federal Reserve’s Chairman was Paul Volcker and he had to raise interest rates to unheard of levels. These rate hikes led to a prolonged economic contraction that was the worst since the Great Depression of the 1930s. This description from Paul Volcker’s, biography on Wikipedia gives a sense of how severe the reaction was [emphasis added]:

However, the change in policy contributed to the significant recession the U.S. economy experienced in the early 1980s, which included the highest unemployment levels since the Great Depression, and Volcker’s Fed also elicited the strongest political attacks and most wide-spread protests in the history of the Federal Reserve (unlike any protests experienced since 1922), due to the effects of the high interest rates on the construction and farming sectors, culminating in indebted farmers driving their tractors onto C Street and blockading the Eccles Building.[4]

Blockading farmers. It sounds almost French, doesn’t it? It’s hard to imagine that scenario now, but those were tough times.

The reason Volcker raised interest rates so aggressively was that inflation went wild in the late 1970s. For example, inflation hit 11.3% in 1979, 13.5% in 1980 and 10.3% in 1981 before Volcker’s harsh medicine began to kick in and inflation moderated to 6.2% in 1982. As inflation ratcheted higher, so did home mortgages rates.

Thirty-year fixed rate mortgages went up to nearly 13% in November 1979 and did not fall under 12% again until November 1985. The peak rate for mortgages was 18.45% in October 1981. 18.45%!

But, even though high interest rates began knocking down inflation, high rates also led to sharply higher unemployment. The unemployment rate peaked at 10.8% in December 1982. However, it had been soaring for years and it remained at 8% or higher until January of 1984.

When you hear politicians and pundits opine that this is the worst crisis since the Depression, just mentally compare current conditions to those of the late 1970s and early 1980s. We had double digit inflation, unemployment and home mortgage rates back then. Let’s see: inflation is around 4%, unemployment is 5.5% and 30-year fixed mortgages are about 6.25%. In other words, we are not remotely close to anything like double digits on any one of these factors, much less all three.

The difficulties we faced in the 1970s and 1980s were far more severe than anything we are seeing now and I am confident that the Fed and the U.S. Treasury will be able to deal with the much more moderate economic problems we are facing. We clearly have issues now, but they are not nearly as difficult as the issues we have successfully overcome in the past.

For more on what needs to be done (see Defending The Dollar and Will Central Banks Stop the Dollar’s Slide?.

Update: Dollar Rallies — Three-Month High vs. Euro

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29 Responses to “How Far Has the Dollar Fallen? And Why? — What’s Next?”

  1. Batmanon 09 Jun 2008 at 6:21 pm

    To what extent was slaying the inflation dragon in the 80′s attributable to falling oil prices in the second half of the decade versus Volcker’s policies? To what extent will high oil prices overpower or even negate the effects of monetary policy going forward?

  2. mockmookon 09 Jun 2008 at 6:25 pm

    I’m having trouble seeing the correlation between the dollar and interest rates shown in the graphs. I don’t think this alleged correlation would pass a statistical test.

    Also, wouldn’t a proper analysis of the dollar vs. euro have to include the interest rate for euros?

  3. Lou Minattion 09 Jun 2008 at 6:34 pm

    Go find a chart of a weighted basket of European currencies vs the dollar prior to the introduction of the Euro. I’ve seen the charts before but can’t find them now. They give a good approximation of the Euro vs Dollar comparison going back for decades.

    I think in 50 years we will still have the greenback. Europe will be back to the franc and lira.

  4. PD Quigon 09 Jun 2008 at 6:53 pm

    While I understand that the typical definition of the economy doing “well” is GDP growth, I would think that we would now be realizing that the massive growth of governmental, corporate and personal debt that fueled the economy over the past twenty years has to be factored in. The $trillions in off balance sheet Level 1 and 2 assets of questionable value and the $trillions of additional federal debt should probably be subtracted from GDP to show the real operating health of the economy over that period. Looking only at GDP when assessing our economy is the equivalent of looking only at a cash flow statement. When you see how seriously our balance sheet has deteriorated, it becomes clearer that we have been mismanaging the business of the USA.

  5. Peteon 09 Jun 2008 at 7:20 pm

    Damn straight. People who say this economy is the worst since the Depression have studied no economic history at all.

    Even the jump in unemployment was no big deal. There were over 500,000 net new people entering the workforce (which strongly suggests seasonal adjustments). Funny how the household survey is an irrelevant error prone survey last month when it shows 300,000 new jobs, but it is etched in stone this month when it shows a 5.5% unemployment rate.

  6. SIVon 09 Jun 2008 at 7:52 pm

    How do we mentally compare the economic statistics from the 70s/80s to today?
    They are not calculated the same way. Inflation/unemployment numbers for that period in the last century would be much lower by todays formulas/method, while conversely , by older methods, today’s would be much higher.

  7. Joel Mackeyon 09 Jun 2008 at 9:27 pm

    I disagree with your analysis. The dollar will continue to slide until the war spending is highly reduced, the government spending on social security and medicare is made sustainable, and the US begins providing more of its’ own oil rather than buying foreign oil.

    Your metrics are not correct. You quote 4% inflation. I assume you are removing the highly volatile energy and food like the government, but here in the real world, the consumers have to eat the 25% to 50% inflation of energy and food. The fixed rate mortgage metric is irrelevant when so many individuals are in ARM’s or HELOCs.

    I expect the euro to test 2 dollars in the next 6 to 12 months, contingent on current or increased troop levels in iraq and afghanistan, and oil remaining in it’s up trend. If the democrat gets elected and troop levels are drawn down, I expect a temporary dip in the euro but still a test of 2 dollars within 24 to 36 months.

  8. Pink Pigon 09 Jun 2008 at 9:54 pm

    Every time there is a price crunch in the oil market, the dollar goes down. This happened in 1973 (not shown on your charts), in 1978 and again recently. The reason for this should be obvious: oil is universally priced in dollars, so countries with strong government-controlled central banks (read: authoritarian societies) react to an increase in oil prices by strengthening their currencies against the dollar. This leads to less pain for them. It also leads to a “weaker” dollar. What is there not to like about this? The price of foreign goods to Americans goes up, while the price of American goods to foreigners goes down. Good for business, I’d say. The only people who could conceivably be hurt by this are rich people with so much money on their hands that the loss of the opportunity to buy foreign products hampers their luxurious lifestyles. Let them eat cake.

  9. [...] blog post on how far the U.S. dollar has fallen and why, reminds me of how much the Federal Reserve must be chomping at the bit to raise interest [...]

  10. Barry O'on 09 Jun 2008 at 11:24 pm

    I know I may get blasted for saying this, but looking at the charts above I have to wonder if there was a certain year when congress changed hands that really affected the economy.

    No, actually I don’t have to wonder. That’s the beauty of math.

    I’m sure it’s still somehow Bush’s fault, but maybe humor me or something.

  11. 93ghiwgt2vclw2on 10 Jun 2008 at 12:45 am

    Wouldn’t a weak dollar be a natural result of the high trade deficit we’ve had for so many years? We keep giving away dollars for imported goods until the other countries have so many dollars they value them less.

    We say the fed modifies interest rates to control inflation but isn’t it really to controll an overheating economy or stimulate a sluggish economy? Is there any point in raising interest rates when inflation is not due to an overheating economy but due to rising cost of imports due to currency fluxuations due to the trade deficit?

    The current situation seems due to natural market forces and therefore the best solutions is to those problems will arise from the reactions of individuals to those market forces: buying fewer imports and exporting more goods and services. Modifying interest rates will only exacerbate the problems and make the eventual solution more painful.

  12. Texon 10 Jun 2008 at 3:44 am

    The dollar/yen 30-year chart is even more telling.

  13. Jim Gibbonson 10 Jun 2008 at 5:11 am

    There is a list of unrelated stuff at the right of the page that cuts off the right hand side of two charts and some text.

  14. paul a'bargeon 10 Jun 2008 at 5:11 am

    Many thanks for a well written piece on the dollar. Even I could learn a lot from this!

    Now, how about putting your insight and writing skills to an analysis of the price of gasoline? That would be much appreciated.

  15. Kurt Brouweron 10 Jun 2008 at 8:21 am

    High interest rates initiated by Paul Volcker cut inflation down to 3-4% by 1983. It was a quick yet brutal way to knock down inflation. No doubt declining oil prices also helped. Most commodities plummeted once interest rates went up.

    If you are having trouble seeing the correlation between interest rates and the dollar, see the chart on the British pound during that period. Paul Volcker was appointed by President Carter in 1979. He raised rates quickly and the chart line on the pound comes down vs. the dollar almost immediately.

    Unfortunately, rising interest rates in the early 1980s really hurt bondholders, mortgage holders and anyone owning a fixed rate instrument. The stock market also suffered as the Dow went down sharply. Once rates began to ease a bit, stocks and bonds entered a long bull market.

  16. Kurt Brouweron 10 Jun 2008 at 8:23 am

    If anyone thinks inflation is bad today, check out this chart on inflation over 200 years.

    http://www.fundmasteryblog.com/2008/05/29/chart-of-the-day-us-inflation-over-200-years/

  17. Jim Gibbonson 10 Jun 2008 at 11:37 am

    Regarding foreign countries strengthening their currencies to offset oilk priced in dollars, how many of the EURO countries produce oil of measurable quantities? Why should the Euro be so strong against the dollar when the EURO countries economic growth lagged the US since 2003 and certainly in years prior AND our inflation rate has been in control as much as the EURO countris, if not better. Yes, we have growth in Treasury debt, but how do we compare with the EURO countries – debt/GDP?

    I was buying French oak barrels from 1998 to 2000 for a winery on the Central Coast of CA – paid for them in dollars and saved the company lots of $$$$. That was the period of EURO lows in dollar terms. Also, remember that we flooded the globne with dollars in the early 2000s to forego a world wide recession. Never hear much about that.

  18. Kurt Brouweron 10 Jun 2008 at 1:17 pm

    Good point Jim. Here in this post http://www.fundmasteryblog.com/2007/11/08/national-debt-at-9-trillion/ is some information on relative debt/GDP of other countries. In general, U.S. debt as a percentage of GDP is competitive.

  19. [...] Read more: How Far Has the Dollar Fallen? And Why? — What’s Next? [...]

  20. Oil & Inflation « Meandering Matrixon 11 Jun 2008 at 2:50 pm

    [...] http://www.fundmasteryblog.com/2008/06/09/how-far-has-the-dollar-fallen-and-why-whats-next/ [...]

  21. link 737 | Molrak.comon 12 Jun 2008 at 5:27 am

    [...] Fundmastery Blog » Blog Archive » How Far Has the Dollar Fallen? And Why? — What’s Next? [...]

  22. KAMAL AHMAD KHANon 21 Jul 2008 at 8:33 pm

    THE ALARMING HEALTH OF THE US ECONOMY

    The health of U.S. has been on the rocks ever since the Gramm-Rudmann-Hollings Law was amended/scrapped by President Bush. The Repercussions on the Consumer/Common man on the street will be felt when the Debt Servicing gets to above 3 Percent of GDP. which it already is. That means inflation will follow for the next 5-7 years followed by a Period of Stagflation possibly 3 years i.e. I see Interest rates back above double digits in 7-10 years. with the economy performing poorly. Recession should show its indication from 2009. Outflow of investments should pick up speed 2009 onwards. Bankruptcies to double in the next 5 years. Unemployment to double in next 5 years. The USD to FALL , the Stock market to Fall to 7,000 levels . The banking sector to lead the way as FDIC doesn’t have enough money to bail out a Top 20 US Bank. The Blame (I Feel) goes ALL to US Congress-Senate especially PRESIDENT BUSH for his policies to gain Votes and popularity NOW at the cost of the Future of the US People as the Consumer/Common people in USA will feel the HIT 5-7 years down the road in a Big way. First Recession followed by Stagflation after 3-5 years will and should be hitting the economy in 2009 onwards as the
    Sub-Prime Mortgage crises is ONLY the forewarning of worse gloom and doom to follow.

    UNLESS AND UNTIL THE TWIN DEFICITS ARE CONTROLLED NAMELY BUDGET AND TRADE DEFICITS THEN IF DEVALUATION OF THE DOLLAR ON A MASSIVE SCALE PLUS SPENDING CUTS ARE CARRIED OUT THE BALOON WILL BURST SOONER RATHER THAN LATER SPELLING GLOOM AND DOOM ON A FAR MASSIVE SCALE THAN 1929 (GREAT DEPRESSION).

    Who is going to Bail out the USA ? EU ? World Bank ? IMF ? Japan ? China ? Who ???

    Have your forgotten that the Governement has increased TAX on OIL and is earning Billions every year and even then the situation is worsening.

    Note what I have written down now as Time will tell you IF I am right or wrong. Today 08 July 2008.
    (This is my analysis and my own working)

    Regards
    Kamal Ahmad Khan
    Analyst/Consultant
    0092-300-2209309

  23. Chrison 13 Sep 2008 at 12:42 am

    The Gramm-Rudmann-Hollings (GRH) law was knocked down the by the US Supreme Court in the case of Bowsher v. Synar, 478 U.S. 714 (1986). President Reagan was in office. The process for determining the amount of the automatic cuts was found unconstitutional. It was reworked in 1987 without an enforcement mechanism and finally, replaced with Budget Enforcement Act of 1990, under President Clinton.

    Mr. Kamal Khan reveals that his opinion is political and are not economic or historical.

  24. Business news and reviewson 23 Oct 2008 at 12:36 pm

    The dollar is currently trading at 1.28 to the Euro. Given that countries like Hungary, which is a prospective Euro member is being harried by hedge funds and the forint is coming under sever pressure, do you see investors losing faith in the Euro long term

  25. Muhammad Yaqoobon 31 Oct 2008 at 10:56 am

    People do not realize the real reason for the Iraq war and the current war threat against Iran by USA. It’s not the nukes, it’s not the terrorism and it’s not the oil. It’s all about the protection and propping up of the greatest con-job in recent history, the US Petrodollar Scam.
    see detail: http://www.fundmasteryblog.com/2008/06/09/how-far-has-the-dollar-fallen-and-why-whats-next/

  26. samuel j quintana Sr. et. al.on 11 Jan 2009 at 1:08 pm

    Fellow general average persons citizens—The GAP Citizens of America:

    Thanks for the 411 on this money-issue challenge [problem, to those who don't scam or hedge.]:

    Like everyone else whose been(being)attacked by our own public service(mis)managers, I have been on a mission to uncover the real value of the current(January 2009)Dollar verses the 1972 $ so I can “hit one over the fence” before a jury of our peers(YOU ALL) in these corrupted dispicable courtroom’s/judges/lawyers, etc. that exist at the expense of the public they are sworn (by mandatory oaths of Public Service) to protect and defend against ALL ENEMIES… even the Domestic one found naked in the public square these days!Same lies, differant faces! They have become sooo entreched in the public domain that it must even be awakening Lazerus; and are now THE DOMESTIC ENEMY OF THE THIRD-PARTY TRUST THAT IS AMERICA.

    So once again thank all of you for revealing the Blue Katrina in the Public Square. The time has come to meet in Boston Harbor for a Tea & Stamp Act Party…. I guess?

    Love & Peace to my Brothers and Sisters out there in CyberSpace for you much needed H20 in this(sic) desert of corruption we call Home “sweat” Home.

    Raven in California.

  27. MKon 30 May 2009 at 2:14 pm

    MK…

    I would have to disagree ,but Mutual funds for beginners? | Business and Finance Question is definately a good read……

  28. [...] heading down, the dollar is getting stronger. When the line heads up, the dollar is getting weaker. for more… i’ve even highlighted the important bit is case you are still unable to understand it. now [...]

  29. Great Depression Factson 07 May 2011 at 8:37 am

    Its nice to glance at this article two years after the post to read comments and were we stood.

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