Economics Commentary - Dollar Hits a New Low, Oil Hits a New High

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Economics HL Portfolio A         Jingming Chen

Economics Commentary - Dollar Hits a New Low, Oil Hits a New High

Recently, the global economy has been struck a lot, mainly due to the subprime debt crisis. So far as the foreign exchange market is concerned, many factors have made contributions to the depreciation of the U.S. Dollar.

The main reason for the sharp depreciation of USD is the unfavorable economy with a sick-into-death credit market that makes domestic and foreign investors disappointed. As it is referred to the article, many economic data released by the US government is quite dark leading people to lose confidence, and have worse expectations towards the US financial market. As a result, people, especially the foreigners, will consider making their investment plan into abeyance and withdrawing the current portfolios in the US. Also, those investors will seek to make new investments in the other healthy market such as East Asia and Europe. This will lead to the decrease in the demand of USD and the increase in the supply of USD, since they do not need any more dollars and want to sell the USD in order to purchase other currencies such as Euro. This series of actions contribute to decreasing the exchange rate of USD against other currencies.

In this diagram, the demand curve shifts to the left and the supply curve shifts to the right, giving a sharp decrease in the price of USD from p1 to p2. (The quantity / trade volume may somehow decrease from q1 to q2, too. But the precise determination needs more accurate data.)

“Lead the Federal Reserve to cut its benchmark interest rate” whereas the ECB is considering raising the rate is another one of the greatest factors that pushing down the exchange rate of dollar against other main currencies. This can be explained in two ways.

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In terms of the price of money, decrease in the interest rate of USD means the depreciation in the value of dollar. While the interest rate for Euro is supposed to get higher, the exchange rate of Euro against USD will definitely raise a lot.

Related to the saving, since it is very probable that the FRB is going to cut its interest rate so that the people who save in US dollars will get lower return per unit period of time, many of them will decide to sell the dollar and buy other currencies with higher interest ...

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