The Declining Dollar: Warning or Opportunity?

Realtors Commercial Alliance Report, VOL. 9, ISSUE 1 ● WINTER 2008

"...The weaker dollar may gradually push up interest rates, making an already tough lending climate even tougher.

...The dollar’s slide is hardly new; it’s been slowly losing ground against most other currencies since 2003. The biggest culprit, all experts agree, is the huge U.S. trade deficit.

...Another contributor was the failure of other central banks to follow suit when the Federal Reserve began to cut rates last fall, says Adolfo Laurenti, senior economist at Mesirow Financial. “This disparity narrowed the differential in interest rates and made the dollar less attractive,” he says. Continued Fed cuts could exacerbate the situation, he believes.

Compounding the slide in recent months is everyone’s favorite whipping boy, residential subprime credit problems. “The subprime crisis has caused a lack of confidence in the U.S. It
used to be seen as a safe haven,” says John Wickes, senior vice president of research for Jones Lang LaSalle. The fact that quite a few European banks are taking major write-downs on failing mortgage backed securities is helping to keep this perception alive abroad, he adds.

...there’s almost universal consensus that 2008 and 2009 will be years of slow growth in the U.S. at best, the fear that a large-scale Chinese sell off of U.S. bonds will plunge the country into a severe recession is a chimera, says Dr. Dwight Jaffee, Haas School of Business, University of California, Berkeley. While the Chinese may continue to increase the value of their currency and shift some of their dollar denominated investments into other currencies, the shift will be gradual, he says. “International trade is a cooperative venture. The Chinese need to keep their currency low in order to continue to sell their manufactured goods. They can’t afford to let the Chinese yuan jump against the dollar.”

Instead, Jaffee expects several more years of the measured 5 percent annual increases he’s seen in recent times. The oil-producing states will most likely follow the same incremental approach to investment shifts, he adds.

...whether you see the dollar’s slide as an opportunity or a hurdle, get used to the new weakness. “The dollar isn’t going to recover any time soon,” says Wickes. Indeed, things may get worse before they get better, as currency markets have a tendency to overshoot, notes Laurenti. Only when the trade deficit returns to the 2 to 3 percent of GDP range—which may require another
10 percent drop in the dollar—will the dollar improve significantly, Laurenti says.

But “eventually, the dollar will return to equilibrium and the trade deficit will stabilize to a lower rate, but we could be talking five to ten years, or even longer,” says Jaffee."

[TJ: That could mean 5-10 years of much higher mortgage interest rates in the U.S., and 5-10 years is the typical real estate cycle. It is best to lock in your 30 yr. fixed rates now while rates are still near 6%.]