Dollar Depreciation: Denial or Acceptance?

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Dollar depreciation

Denial or acceptance

Oct 22nd 2009From The Economist print edition

The dollar’s slide is complicating life for countries with floating exchange rates Illustration by S. Kambayashi

IN ONE sense, a weak dollar is good news for the world. Behind the global economy’s current revival is a returning appetite for risky investments, such as equities and corporate bonds. At their most panicky investors shunned all but the safest and most liquid assets: American Treasuries were a favoured comfort blanket. That demand for safe assets prompted a rally in the dollar in the months after the collapse of Lehman Brothers last September.

Now that stockmarkets and economies have bounced back, dollar weakness has returned, causing a headache for countries with floating exchange rates (see chart). That has prompted three responses: direct measures to stop currencies rising; attempts to talk them down; or acceptance of a weak dollar as a fact of life.

Brazil has gone for the direct approach. Foreign capital has flooded in, attracted by the healthy prospects for economic growth and high short-term interest rates. That has pushed up local stock prices, as well as the real, Brazil’s currency. To stem the tide, the government this week reintroduced a tax on foreign purchases of equities and bonds. Though many doubt the long-term efficacy of such measures, it had an immediate effect. The real, which had risen by more than one-third since March, fell by 2% (before regaining some ground). Brazil’s main stockmarket dropped by almost 3%.

Others have resorted to talking their currencies down. In a statement released after its monetary-policy meeting on October 20th, Canada’s central bank said the strength of the Canadian dollar would more than offset all the good news on the economy in the past three months. The currency’s strength would weigh on exports, said the bank’s rate-setters, and mean that inflation would return to its 2% target a bit later than previously forecast. Foreign-exchange markets took the hint: the Canadian dollar fell by 2% against the American one after the bank’s statement.

Europe’s efforts to contain the dollar’s weakness have had rather less impact. This week the dollar slid to $1.50 to the euro, just as Henri Guaino, an adviser to Nicolas Sarkozy, the French president, described such a rate as a “disaster” for Europe’s economy. Mr Sarkozy has often moaned about the harm done to exporters by a muscular euro.

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