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The Dollar Nosedive

Why America's Currency Is the World's Problem

Part 6: A World-Wide Economic Slowdown?

So is the situation not as bad as it looks? It may not be. But no one knows whether the dollar will continue to fall -- or, if it does, how rapidly.

Individual companies are already hard hit, especially small to mid-sized companies that have not adequately offset their expected dollar revenues and that lack the big corporations' resources to build factories in the United States. But all other industries will also feel the effects of a worldwide economic slowdown in the wake of the dollar crisis.

Some experts hope that an opposing movement will begin in the foreign currency markets, as it did more than three years ago, when the euro kept rising, and it was only a matter of time before it would reach the $1.40 mark and then the $1.50 mark, or even, as experts feared, would climb to $1.80.

But the exchange rate suddenly stopped climbing at $1.40, when speculators cashed in and unloaded their call options. The dollar recovered and the specter of a crash seemed to have been averted.

Now it's back. Nothing has really changed since then. The Americans -- the citizens and government alike -- continue to live beyond their means. And economists agree that as long as this continues, the tendency will be for the dollar to lose value.

But opinions are divided over what happens next. There are three possible scenarios. Which of them becomes reality will depend on whether the participants behave more or less rationally -- or whether panic breaks out.

In the best-case scenario, the dollar's decline will slow down. Americans will tighten their belts, saving more and spending less. Imports will decline while exports grow, because American goods will be cheaper and more competitive. The foreign trade deficit will shrink and the dollar's fall will end.

Perhaps the Chinese will even agree to a revaluation of their currency.

The world economy will settle into a new equilibrium. But even in this case it will suffer, as all experts have scaled back their forecasts for the coming year. Nevertheless, they still expect positive growth rates. This is not what a recession looks like.

This could change if -- in the second scenario -- the subprime crisis continues to grow, possibly expanding into consumer loans. In this case -- when the "infection spreads," as a leading German banker puts it -- banks would be forced to make far more drastic value adjustments. Not only would this poison the spending climate, but it would also undermine foreign investors' confidence in the US economy. This in turn would lead to a far more substantial slide in the dollar's value, and probably a crash on the markets, which are still at surprisingly high price levels today.

This would deal a double blow to the German economy. Not only would it adversely affect exports to the United States, but the damage to the world economy would be so substantial that it could no longer be offset by booming Asia. The Asians are still driving the global economy today and there are no signs of looming crisis in their own economies. If a US recession affects the economies of these nations, they too will reduce their orders for German goods, more than likely leading to a recession in Germany.

The first two scenarios are based on the assumption that the affected countries remain levelheaded. But what happens if the dollar just keeps on falling? What if fear of a permanent decline in values spreads in all of those countries that have accumulated vast quantities of the US currency in the past few years, countries like China, Japan and the Asia Tiger states, as well as the oil-exporting countries and Russia? What if panic breaks out and the new mantra is to "get out while you can?"

If that happens -- and this is the horror scenario -- the dollar will crash and, along with it, the international financial markets. Then the globalized world will be in a worldwide depression. This scenario is less likely, because promoting it cannot be in anyone's best interest. And yet it cannot be ruled out completely, as even the most sensible bankers privately concede.