Question about why the currencies fall

[OrrLives]

Sorry for the super-noob question... but why exactly is the dollar falling?

I've read from multiple sources that the dollar has been falling due to both the (1) growing trade deficit and (2) increasing federal budget deficits. But how do these two forces make the dollar 'worth less' than the Euro in financial markets? And yes, I did do a google search on this topic before posting. Most websites list the above two reasons and explain the implications of a falling dollar, but I am interested in the details of why individuals would want to sell dollars and buy other currencies (say, the Euro).


I understand why stocks and goods prices fall...

If many believe that a company will do poorly in the future (or offer less dividends than another company), then there will be little demand for that company's stock. Stockholders will have to lower the price of their stock in order to sell their shares.

Similarly, if there is little interest in a particular good, the seller will have to lower its price until there are a sufficient number of buyers.


But I am having trouble understanding why the dollar would fall.

If a nation prints off a lot of currency, I understand that the inflation rate will rise and a currency will be worth less as its purchasing power decreases. I also understand how political upheaval would cause a currency's value to change depending on whether the incoming government is perceived as fiscally responsible. But these don't apply to the U.S., do they?

Is the dollar falling (in part) because of people's lack of confidence in the U.S. government to pay off its debts? (which are mainly in treasury bonds, correct?)

How much of the falling dollar due to group psychology? (e.g., 'omg I heard the dollar is falling so I should put all my money in Euros' and the dollar slides further.)

[Zygote]

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Sorry for the super-noob question... but why exactly is the dollar falling?


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supply and demand. This is the rule that sets and adjusts all prices.

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ve read from multiple sources that the dollar has been falling due to both the (1) growing trade deficit and (2) increasing federal budget deficits.

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these numbers aren't fully directly correlated with the currency moves per se. Deficits can be deceiving too if you dont keep track of the income accounts and societal credit.

In general though, if you ship out more wealth than you take in, your country is slowly losing the underlying wealth. This means bond holders are taking increasingly greater risk since there is less wealth to support the stability of the currency.

If the federal government goes broke they will need to raise taxes, cause hyperinflation, and/or increase interest rates. All of them, except for the last option, dont fare well for the country's wealth or growth prospects which will have negative impacts on the economy and therefore the currency.

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But I am having trouble understanding why the dollar would fall.


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Supply and demand. If the buyers of dollars outweigh those who sell dollars, the price will rise because all available quantities for sale at a given price will have been eaten up and exchanged by the buyers leaving wave of buyers now standing by a higher bid price. If you reverse this from sellers to buyers the effect will be the same but on the downside.

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If a nation prints off a lot of currency, I understand that the inflation rate will rise and a currency will be worth less as its purchasing power decreases. I also understand how political upheaval would cause a currency's value to change depending on whether the incoming government is perceived as fiscally responsible. But these don't apply to the U.S., do they?

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Why not? The US has printed a ton of money and printed more money to monetize their debt. Future interest payments on foreign debt are going to take up all federal revenues within not much more than couple decades. They are also printing tons of money too keep their bubbled economy afloat with a variety of bailouts. The fiscal outlook has serious problems within every category, most specifically now is the entitlement problems though.

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Is the dollar falling (in part) because of people's lack of confidence in the U.S. government to pay off its debts? (which are mainly in treasury bonds, correct?)


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The dollar falls because people's lack of confidence aren't being compensated by high enough yields. When the dollar rebounds it will be because higher interest rates encourage savings for the dollar.

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How much of the falling dollar due to group psychology? (e.g., 'omg I heard the dollar is falling so I should put all my money in Euros' and the dollar slides further.)


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There is way more dollar buying for political reasons, like china, then there is people getting out of the dollar for no good reason other than their mental state. The general psychology does have an effect, but this psychology is by no means irrational. Currencies like the dollar can't make significant moves due to minor irrational psychological trends unless motivated by political forces. There just isn't enough irrational money out there to support that and the flooding of irrational money will cause significant buys.

[OrrLives]

Thanks for taking the time to answer my question.

I realize that it is all about supply and demand (just like any other stock), but upon further reflection I think my problem is that if the dollar falls X% versus another currency, does that mean investors have X% less faith the U.S. will be able to pay back its debts and/or remain financially stable?



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The dollar falls because people's lack of confidence aren't being compensated by high enough yields. When the dollar rebounds it will be because higher interest rates encourage savings for the dollar.


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This has confused me as well. I understand that if the interest rate increases, investors will become more interested in the dollar because they will make more money. But doesn't this mean that the federal government will just have to pay back more money down the road, further eroding confidence in the dollar?

Without raising taxes or reducing government spending, would raising interest rates be harmful in the long run to the dollar?

[Zygote]

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I realize that it is all about supply and demand (just like any other stock), but upon further reflection I think my problem is that if the dollar falls X% versus another currency, does that mean investors have X% less faith the U.S. will be able to pay back its debts and/or remain financially stable?


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This only means the short term sellers outweigh the buyers, with respect to the dollar versus the other currency. How you interpret this relative to overall currency confidence isnt necessarily implied. If the dollar falls perpetually, versus all things the dollar can purchase, however, this would be an almost definite sign of loss in dollar confidence versus all other assets.

Also, the dollar falling against one currency may be strength in that currency rather than underlying weakness in the dollar compared to assets other than that currency pair. In a way you could say short term confidence resides higher with the specific appreciating currency relative to the non-appreciating currency, but this doesnt automatically imply anything substantial about the non-appreciating currencies overall confidence.

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This has confused me as well. I understand that if the interest rate increases, investors will become more interested in the dollar because they will make more money.

But doesn't this mean that the federal government will just have to pay back more money down the road, further eroding confidence in the dollar?


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National commercial banks borrow cash and assets from each other to cover shortfalls in their trade flow and therefore reserves. Banks that save and are compensated provide the reserves for those that borrow and pay interest. When the banks start charging a rate of interest above the fed funds rate, because the banks lose confidence at the old yield rate of loans, the fed will inject cash into bank reserves until the rate they charge comes down to the feds target. If the rate falls below the fed target they will withdraw reserves.

When the fed is persistently injecting cash to maintain artificially low rate then the currency will be severely hurt because these reserves are created out of air and heavily expanded by the banks through the credit multiplier effect as cash goes from bank to bank each with small reserve requirements creating more and more credit in the process. Anyone owning dollar denominated assets, including bond holders, now face greater risks relative to the yield they accepted on a security since the dollars they get paid back in will have decreased purchasing power. This will start to crunch credit markets and what they've financed as the cost of borrowing rises. This means interest yields will be driven up, assuming there aren't major foreign political repurchases and the fed has run out of steam.

It means the economy will have to slow down. The society will need to focus on savings and getting out of debt. There will be higher interest paid on loans but thats the price of borrowing when you have bad credit. Thats the only way to get loans. Hopefully this will encourage the economy to stop borrowing, slow down on consumption and spending, get back to producing and then they will be on an effective path.

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Without raising taxes or reducing government spending, would raising interest rates be harmful in the long run to the dollar?

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Raising interest rates is positive for the dollar relative to the previous position in the long run since savings is more rewarded and therefore likely in more demand.