The USD has had a nice upsurge in recent weeks as it broke long-term resistance. Many economists explain this as a direct result of gold, oil and other commodities taking a plunge. Since 2002, gold and other commodities have made higher highs each time breaking expectations; while at the same time the USD is about 40% below its highs since the beginning of the century. However, putting the dollar’s recent “strength” into perspective, the dollar index is still well below that important 0.8 level, currently sitting at around 0.77.

In other words, while there is a short-term rise in the dollar, particularly against the Euro (58% dominant in the index), the long-term outlook is still quit weak. Certainly, the underlying US economy is in bad shape as fundamentals are deteriorating, inflation is at an all-time high, consumer spending is down and high systemic risks remain. Many economists argue that rebound in the dollar is a signal that the US economy is recovering, while the rest of the world continues to decelerate.

Some believe that the world’s problems result from dollar weakness and that pushing the dollar up would be beneficial. For example, since the weak dollar is contributing to the rise in oil prices, a stronger dollar should help bring prices down. However, if foreign governments weaken their own currencies to push the dollar up and bring oil prices down for Americans. Oil prices will go up for their own citizens. This is not an attractive bargain for any foreign country.

Conventional wisdom suggests that foreign economies depend on Americans to buy their exports; however, this is likely false. Globalization in the past few decades has created demand everywhere; people and businesses in all parts of the world are spending. In the United States, spending has been achieved largely as a result of a financing system funded by foreign credit. Total US debt held by foreign governments is 25%, double the figure in 1988 (US Dept of Treasury).

As this credit goes bad, losses are landing on the bottom lines of foreign financial firms. One way to avoid these losses is to reduce lending to the United States. While this will marginalize the dollar as it drops to its “natural” level, this will allow the economy itself to recover as it decouples from foreign dependence.

The weak dollar is merely a result of structural problems underlying the economy. In order to achieve global economic balance, there can only be a weaker dollar. Efforts to artificially prop up the dollar may be beneficial in the short-term; the long-term consequences can be substantial.

Disclosure: None