Economic Snapshot | Trade and Globalization

The stock market correction and the resilient U.S. dollar

A weekly presentation of downloadable charts and short analyses designed to graphically illustrate important economic issues. Updated every Wednesday.

Snapshot for March 28, 2001.

The stock market correction and the resilient U.S. dollar
Since early 2000, the U.S. stock market has been falling, leaving many investors to fret about the losses in their portfolios. But some are more hopeful about the stock market correction, especially the more gradual decline that took place in the second half of 2000, which seemed to lay the foundation for a drop in the value of the U.S. dollar.

If the U.S. dollar devaluates, exports from the U.S. should become more competitive, and imports from overseas should increase in price domestically, thus allowing the trade balance a chance to shrink from its record high. For this to happen, though, the devaluation has to happen gradually, so that the U.S. manufacturing sector can make the necessary adjustments to meet rising overseas and domestic demand.

During the last weeks of 2000, reality seemed, for once, to mirror economic text books. After the stock market had already lost a substantial share of its value, the dollar began to fall against the currencies of the U.S. trading partners (see figure below). As domestic and international investors analyzed the fundamentals of each currency more carefully at the end of 2000, some of the major U.S. trading partners, especially those in Europe, seemed to be in better shape than the United States.

Figure 1: Stock market and exchange rates

However, the first weeks and months of 2001 make the decline in the value of the dollar look more like an aberration rather than a confirmation of economic theory. In fact, as the stock market continues to correct for overvaluation, the more the value of the dollar rose. Thus, American products remain overvalued on overseas markets, and imported products remain too cheap. Consequently, the trade balance may continue to grow, even amid a weakening U.S. economy.

Also, the continuously strong dollar will also help to bring more capital into the U.S., thereby raising our overseas indebtedness and the financial fragility of the U.S. economy (see the Snapshot from March 14, 2001).

This week’s Snapshot by EPI economist Christian E. Weller.

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