>The cause of the dollar’s weakness is different, and less durable than before the crisis

Before the crisis, the dollar’s weakness was mainly caused by the US external deficit due to the shortfall in savings. It resulted in a continuous rise in the US external debt, and therefore a long-term trend depreciation of the dollar.

Since the second quarter of 2009, the dollar’s weakness has mainly been due to capital outflows from the United States, due to the very low level of interest rates. The potential for dollar weakening is greater than before the crisis, due to the magnitude of the capital outflows. However, if the US household savings rate remains higher, investment lower and the US trade deficit accordingly becomes smaller, this dollar weakness will be temporary and not permanent, as it will disappear when dollar interest rates rise again due to the future improvement in the economy. This will, nevertheless, take time: interest rates must rise again in the United States up to the point where capital stays in the United States.

1 - Dollar weakness until the Lehman bankruptcy
Until the summer of 2008, the dollar’s weakness (Chart 1) was mainly due to the widening of the US external deficit (Chart 2) due to the decline in household savings (Chart 3); or in an equivalent manner, the rise in their indebtedness (Charts 3 and 4).

2 - The dollar’s weakness since the beginning of the second quarter of 2009
The crisis caused an upturn in the US household savings rate (Chart 3 above) and a fall in investment (Chart 7), and hence a marked reduction in the US external deficit (Chart 2 above).

3 - A major difference impacting the duration of dollar weakness
When the dollar’s weakness was due to the US external deficit and the accumulation of external debt before the crisis, it had a structural, durable cause: the shortfall in savings. One could therefore anticipate a lasting depreciation of the dollar in the long term.

Since the second quarter of 2009, the dollar’s weakness has been accounted for by a different cause: the capital outflows due to the low dollar interest rates. The upturn in Americans’ savings and the fall in investment (productive and housing) have eliminated the US trade deficit as the main cause behind the dollar’s weakening. The difference from the pre-crisis situation is that there are cyclical reasons for the dollar’s weakness: the Federal Reserve’s low interest rates due to the weak US economy (Charts 11A, B and C), which explains the high unemployment and the very low inflation.

To read the charts and report: SPECIAL REPORT