The Dollar: A Bottom at Last?

After years of weakness, the U.S. currency may be at a turning point. Who would gain—and lose—from a greenback comeback?

by Ben Steverman

There's a growing sense among currency traders that the U.S. dollar might finally stop its long slide against other major currencies.

The euro almost hit $1.60, a record high against the dollar, on Apr. 22, the same day the dollar index—a measure of the greenback against a basket of major currencies—also showed record weakness.

But since then, the buck has been on a modest upswing. The euro traded at $1.54 on May 2, and the dollar index is 3% off its lows. "We think the dollar is carving out a bottom," says Meg Browne, senior currency strategist at Brown Brothers Harriman.

The main cause of the dollar's recent strength is the same reason for its rapid collapse over the past year: the U.S. Federal Reserve. The dollar's value suffered when the Fed cut interest rates rapidly to stem the financial crisis and prevent a U.S. recession. The turning point may have been on Apr. 30, when the Fed lowered the fed funds rate target by a quarter-point, dialing back on its policy easings after a series of half-point cuts. Many believe the central bank is putting its rate-cutting on hold for now.

Exports Enabler

Other recent lifts for the dollar have come from hopes for a second-half recovery for the U.S. economy, and worries that other countries' economies are slowing, which could force their central bankers to cut rates.

For some politicians and popular commentators, the weak dollar can be a sore spot. Listed alongside economic ills such as financial market turmoil, high oil prices, falling home prices, and weak consumer spending, the falling dollar is seen as a symbol of declining American prestige.

Most economists say the reality is far more complicated. A cheap currency might reflect economic weakness, but it can also give the economy a shot in the arm. U.S. manufacturers, for example, love a weak dollar, because it makes U.S. exports more competitive abroad. That helps companies such as Caterpillar (CAT) and Boeing (BA), which recently reported strong financial results despite a slowdown at home.

Brian Gendreau of ING Investment Management (ING) points out that since 2006 exports have added $150 billion to the U.S. gross domestic product. That offsets most of the $170 billion drag on the economy from the weak housing market.

Away with Asia's Artificial Lows?

L. Josh Bivens, economist at the left-leaning Economic Policy Institute, argues that the dollar was an "unsustainably high bubble" a few years ago, which robbed U.S. workers of millions of manufacturing jobs. Many mainstream economists agree with Bivens' analysis, if not his policy prescription: Tough negotiations should force China and other Asian countries, which keep their currencies at an artificially low level, to raise their values against the dollar. That would give U.S. manufacturers an even bigger advantage.

Such a move would also surely raise costs for U.S. consumers. High oil and commodity prices can already be partly blamed on the dollar's weakness, which points to a big disadvantage of a weak currency. Bivens says U.S. consumers have been getting a bonanza. "We expected things to be cheaper than they should be," he says. An adjustment is "necessary to bring the economy in some sort of balance."

Higher prices for food and energy squeeze consumer spending, which hurts U.S. retailers and other consumer discretionary firms. But higher costs also can squeeze profit margins at firms. Kraft (KFT) and Procter & Gamble (PG), giants of food and household products, respectively, said they're being forced to raise prices because of higher raw material costs.

Of course, currency weakness is only one part of the rise in commodity prices.