As the U.S. dollar continues to fall in value against foreign currencies and has reached record lows against the Euro, some are beginning to wonder about the state of the American economy.
This week I sat down with Max and Herta Neubauer Professor of Economics Yannis Ioannides, who is an expert on macroeconomics, economic growth and housing markets, to discuss the fall of the dollar and its implications.
Jamie Bologna:The U.S. dollar became equal to one Canadian dollar on Thursday for the first time since the 1976. Coupled with the current strength of the Euro currency, what does this mean for the American economy?
Yannis Ioannides: The key thing with the value of the U.S. dollar, as it is with the value of any currency, is you have to think about the price that goes into the all the things we import and also into the prices of the things we export.
So if the dollar goes down, relative to other currencies, the things we import become more expensive and the things we export become cheaper [and if anything] that's a good thing for the U.S. economy.
JB: Some of this raises the question of central banks changing their reserves to the Euro.
YI: The U.S. dollar is the hegemonic currency of the world. [But] there is no doubt that the Euro is becoming a very respectable currency. When the Euro was introduced nearly nine years ago January 1st, there was a lot of uncertainty about how it was going to do. There is less uncertainty now in part because the institution that administers the European currency, the European Central Bank, has taken very respectable positions. ...
I don't think it is going to happen very soon, that the dollar will be threatened in its role as a reserve currency. It is important to remember that the value of the dollar stands where it stands because a lot of governments are willing to lend to the United States government by buying up government securities, which helps us finance our debt. ...
The real issue is whether it is going to go with a big drop or it is going to go gently down, which has pretty much been happening for the past few years. ... If the dollar does go down really rapidly, will this have macroeconomic effects? This isn't just a problem for the dollar or for us only, but it is a problem that is too big to contemplate for the rest of the world. Literally the entire world holds enormous wealth in the form of United States government securities. Consequently, no one really has an interest in [letting] this happen.
JB: The Federal Reserve recently cut interest rates. How does that play into all this?
YI: The reason they did that was because they were worried about a liquidity problem associated with subprime mortgages. Most experts agree that they did the right thing in lowering rates. The consequence of that is it obviously helps prevent a domestic economic crisis but it also helps avert an international crisis as well.
JB: So can subprime lending drastically affect the U.S. economy?
YI: Yes, that's why the Federal Reserve did what it did. Subprime lending is the practice of lending very liberally to people who in harder times, banks would not have lended to. Mortgages are securitized; when a loan is made it is then chopped up in different ways ... and is sold to different banks. The consequence of that is the risk is spread too thin and there is a systematic factor in all these loans, since many people are going to be affected. ...
It is quite important because more than half of our personal wealth in the United States is in the form of houses. Consequently when our wealth goes down because the values of our houses go down, we become poorer, we feel poorer and we buy less.
JB: How would you asses the state of the U.S economy right now?
YI: What's happening right now will help avert protectionism, which is a terrible thing. There's an incredible amount of dynamism in the U.S. economy, and it [is] forgotten when things sour up. I think there's also a political factor associated with Iraq. The war there is costing much more than the government let people believe. That's all part of the equation: the prices of energy and instability in an area where there are a lot of energy resources. And the more they [stabilize] things, the more secure the financial markets will become.
