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The Myth of Dollar Strength in 2005 Essay

The rise of the U. S. dollar in 2005 has been remarkable, especially after it was not expected to do so well against the rest of the world. Higher interest rates make foreign investors eager to acquire American assets, thus driving up the dollar’s price that year. According to an article in Business Week, “Foreign companies and investors still have confidence in the American economy. ” (Cooper and Madigan, par. 2) Of course, we all know that what happened a year later. The dollar has been a ticking time bomb since the U. S. economy started accumulating huge current account deficits.

In the balance of payments model, “a foreign exchange rate must be at its equilibrium level – the rate which produces a stable current account balance. A nation with a trade deficit will experience reduction in its foreign exchange reserves which ultimately lowers (depreciates) the value of its currency. ” (“Exchange Rate” BOP model). Eventually, the dollar will have to go down, despite the confidence of investors in the economy.

The Business Week article also held to this economic model, but it made a bold assumption that foreign direct investment to the U. S. would mask the deficit in the current

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account, as well as U. S. issued securities such as Treasury bonds and corporate equities (Cooper and Madigan, par. 4), which are made more attractive by relatively high interest rates in the U. S. compared to the rest of the developed world. After a while though, the consequences of running trade deficits with everybody is going to hurt. And with the current administration unwilling to start policies that would encourage savings to balance out America’s books (“A Weak Dollar and the Fed”, par 5), it wasn’t much of a surprise to see the MONSTROUS weakness of the U. S. dollar since 2007 until the present.

R E F E R E N C E S

Cooper, James C. and Madigan, Kathleen. “The Dollar Is Still Defying Gravity. ” Business Week. 12 Dec 2005. 17 Feb 2008. < http://www. businessweek. com/ magazine/content/05_50/b3963078. htm> “Exchange rate. ” Wikipedia: The Free Encyclopedia. 12 Feb 2008. 17 Feb 2008. < http://en. wikipedia. org/wiki/Exchange_rates> “A Weak Dollar and the Fed. ” New York Times. 8 Aug 2007. 17 Feb 2008. < http://www. nytimes. com/2007/08/08/opinion/08wed1. html>

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