The Dollar Bailed Out!

The US House approved the massive $700 billion package finally, after having rejected it earlier last week. The earlier rejection of this badly needed package seems to indicate that lawmakers were opposed to using taxpayer’s money to bail out the financial system. But, it appears that after a dose of education and some added sops, the lawmakers changed their stand. What effectively it means is that the general public stood to loose their savings, mortgages, pensions etc if institutions were allowed to collapse. This would have hurt not only the entire financial system, but also the taxpayers and the financial panic would have spread to other parts of the globe.

The $700 bailout package is not as bad as it appears. It is typically a Keynesian tool, which allows the increase of government spending to shore up an economy. The taxpayer’s money that is invested can lead to a budget deficit, which could be wiped out with budget surpluses in subsequent years, once the economy revives. In fact, the values at which the US government is expected to pick up financial instruments in various financial institutions are at abysmally low valuations. Once the economy revives and the financial health of various organizations is restored, the government could offload its holdings and make profits, which could be used for the taxpayer’s benefit.  It then appears to be a win-win situation. In any case, the current financial crisis left the government with little other choice.

The sweeteners that helped lawmakers change their stance includes guarantee on bank deposits up to the first $250,000 held by individuals at any bank in the US, up from $100,000 proposed earlier. $100 billion worth of assorted tax breaks was also thrown in. The new Bill also introduces limits on golden handshakes or severance packages for Wall Street executives.

The news of the bailout package being passed by the US lawmakers led to a fall in the dollar vs the Euro as the US financial mess is expected to deepen before the bailout package starts having a positive impact. There was also speculation that the US Fed may cut interest rates in order to boost growth and may ignore inflationary pressures for now. A rate cut reduces demand for the dollar as the overseas demand for US treasury paper declines and the dollar can be expected to fall.

The US dollar may be expected to display an erratic trend in the near future as it is very sensitive to economic developments at this point of time. Thus, news of a rise in unemployment is likely to have an adverse impact on the dollar’s value, while positive developments could prop it. In the medium to long term, as the bailout package starts to stabilize the financial system, the dollar should display signs of strength. But, one needs to bear in mind that dollar strength will depend upon how the economic scenario unfolds in the US as also upon the performance of other major economies like Europe and Japan.