Answer to Question #49250 in Microeconomics for Shant

Question

This is what my Principles of Microeconomics teacher posted for the 30th of November. He did not add anything additional to this, it must be in MLA format and everything must be cited, he is super picky with this and warned us all about plagiarism. Here is what he is asking from us:


The essay is to be written on a topic chosen by the student with a maximum of 1.000 words. This can be on a topic in the press or an ordinary life observation made by the student. In any case, it must employ one of the analytical tools or concepts explained in class. The ethical standards of a scientific working style apply.

Answer 1

Why the US Dollar is Falling
Since 2001 the dollar has fallen by 33% against the euro and by 15% against the Japanese yen (source Economist 9/02/2004). The Dollar has continued to be weak upto the end of 2009. There are many reasons for this.
1. Large current account deficit.
The US had a very large current account deficit of 5.9 % of GDP or $590bn. This requires the US to attract an equal amount of capital flows. This includes both short term capital flows such as hot money flows , and long term investment.
Asian countries such as China and Japan have to some extent been willing to use there current account surplus to save money in the US e.g. buying US govt securities. However recently this has not been sufficient. Therefore this will lead to a depreciation in the $ as the supply of sterling (to buy imports) is greater than the demand for $ (demand for US exports and US securities).
To some extent many Asian countries have a vested interest in maintaining a strong Dollar. This is because they have so many dollar assets. If the dollar was to be devalued they would lose a lot of money.Therefore they feel obliged to keep buying the dollar to keep the valuehigh. This only delays the inevitable. It certainly doesn’t deal with the underlying weaknesses of the US economy. When the adjustment comes it will perhaps be more painful.
2. Low interest rates.
It is argued that devaluation is likely to continue because the US interest rate is very low (Fed reserve rate = 1.5%). Interest rates on US govt securities are close to 1.5%. (In 2009 now 0.5%) therefore thereis little incentive for Asian countries to continue buying US securities at such a low interest. The Fed reserve has not indicated that it will significantly to increase interest rates because the inflation rate is still very low.
3. Low levels of saving and high levels of imports
US consumers are consuming a very high % of their income; the savings ratio fell to 1.3%. Therefore as spending increases so does the demand for imports there is a particularly big deficit in the trade in goods account. As well as high private spending the govts budget deficit is set to soar to a record $520 billion (almost 5% of GDP). This also causes weaknesses in the $