IN A seemingly inexorable process, the US dollar again fell to a new low against the euro on foreign exchanges yesterday. Over the past two years, the dollar's exchange rate against the euro has declined by more than one quarter. The proximate causes of the dollar's difficulties are clear. After prolonged expansion, the pace of US economic activity has lost momentum in recent months.
President George W Bush said yesterday that the US economy was heading for a slowdown rather than a recession. Despite his assurances, the jury remains divided on the final outcome. However, in itself, the steep slowdown already seen in US activity levels would have been sufficient to prompt investors to sell dollar assets.
The response of public authorities to the recessionary threat has accentuated the flight from the US currency. Perversely for a Republican administration of a free market hue, traditional Keynesian policies have been dusted down and deployed in an effort to forestall the onset of recession. Already, President Bush has introduced a $170 billion expansionary fiscal package, a clear signal that this is an election year.
The Federal Reserve Board - the US central bank - has cut interest rates aggressively. Since last summer, the Fed has reduced its key interest rate from 5.25 to three per cent. On Wednesday, the Fed indicated that interest rates would be cut further if US economic conditions continued to deteriorate. This caused a further exodus from the US currency. Investors switched to the euro, which offers higher interest rates and firmer growth prospects.
While the cyclical downturn in US growth provides an adequate explanation for the dollar's recent weakness, it cannot account for its long-term decline. More powerful forces are at work. The continuing inability of Americans to live within their means, the rising costs of running the war in Iraq, the emergence of China as a global economic power and the intractability of the subprime lending crisis within the US have acted in concert to erode long-term confidence in the US economy.
The dollar's descent on foreign exchanges poses particular problems for Ireland. The US is Ireland's largest single foreign customer. It purchases almost one-fifth of Ireland's merchandise exports. A declining dollar will make Irish goods more expensive for US consumers. As a result, Irish enterprises exporting goods to the US will be forced either to forgo sales or to accept lower prices and profits. These competitive pressures will not be borne only by exporters of goods. Exporters of services - principally tourism, business and financial services - will be faced with the same stark choice.
Nor are the difficulties caused by the dollar's decline confined to the US market place. Sterling has fallen in sympathy with the dollar, though not to the same extent. The British market is by far the most important export market for indigenous Irish enterprises and particularly for the food industry. Exporters to Britain must now contend with an exchange rate against sterling that is edging towards parity in terms of the old Irish pound.