Is The Dollar Shine Back?

After having taken a beating for nearly six years, the US dollar seems to be getting back its sheen. Factors like the massive US twin deficits and the emergence of the Euro led to a shaky dollar for a prolonged period of time. While the massive US trade and current account deficits meant that the nation was spending more than its means and other nations continued to finance these deficits, pressure seemed to be building up for a correction in the dollar’s value. The emergence of the Euro challenged the US dollar’s hegemony and somewhat dented the demand for the greenback. Nations like Venezuela and Iran talked about pricing their oil in Euros. The most obvious outcome of these developments was a pressure for a correction in the US dollar. The late US housing slump triggered a faster downtrend in the US dollar and a correction in the general economic imbalances.

Of late, the US dollar seems to be perking up.  But, is this a long lasting trend or is it just because the US economy seems to be getting back on track, while the economic malaise is spreading to the other parts of the world and pulling down economies like Europe and Japan. The truth seems to be the latter case.

The US economy demonstrated better performance, with the Commerce Department reporting a 3.3% annualized growth rate for the April to June 2008 quarter as opposed to expected growth of 1.9%. At the same time, US consumer sentiment seems to be getting better, though the mood was dampened by growing inflationary pressures and a drop in personal incomes.

While the US economy seems to be displaying some signs of strength, the European and the British economies seem to be getting feeble. As per a new OECD report, the British economy is all set to shrink in the coming quarter, while the economies of Italy and Germany will stagnate. France, as per the report, may display some growth, but not enough to keep the European zone out of the red. Thankfully, for Europe, inflation is expected to ease off, which might help in a faster recovery. According to the report, the housing slump is as yet unfolding and unleashing its impact in Europe as also in the US, but in the US the worst may be over.

The news on the Japanese economy is not encouraging either. The OECD has revised its growth projection downwards for 2008 by 0.5% to 1.2%. The Japanese economy also seems to have been hit by a spurt in inflation after years of deflation. The inflation also seems to have been imported due to a rise in costs of imported goods and is not due to an increase in consumer spending. The inflation is not only dampening consumer spending, but could result in a downward spiral for the economy as the Japanese central bank may need to tighten monetary policy to fight inflation. A tightening of the monetary policy will squeeze the already depleted consumer spending and investment, leading to a negative spiral for the Japanese economy.

Thus, it appears that while the world’s largest economy seems to be displaying some signs of recovery, Japan, which is the world’s second largest economy, seems to be getting into a slump. Other key economies like that of Europe also seem to be getting deeper into the negative phase. The most obvious outcome of these developments should be thumbs up for the US dollar. And that exactly seems to be the case. But, whether this will be a sustainable trend is hard to say as it seems to be an outcome of the dollar doing better because the others are sinking! On the other hand, currency traders may be betting on the dollar as they have eventually figured it out as the best store of value!!