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How weak dollar impacts pocketbook

Shrinking dollar in hand
Highlights
  • The dollar is measured against other currencies, and lately it's been weak.
  • In the short term, it signals economic weakness; in the long term, inflation.
  • Consumers get hit in the job market, at the gas pump, on trips abroad.

Fears about a weak dollar are beginning to reach a fever pitch, and some are worried. But are these worries justified?

The dollar's strength is judged against other currencies, and lately it has compared poorly against major rivals such as the Swiss franc, the Japanese yen, the Australian dollar and others.

When a dollar buys more than its equivalent in another currency, it's considered strong. When it buys less than its equivalent, it's weak. For instance, recently a dollar was worth 0.69 euro, and conversely a euro was worth $1.43 -- a great deal for, say, Germans, but not so good for Americans. That's because German consumers have more buying power in the global marketplace when the euro is strong.

Despite all the public hand-wringing on the issue, the actual exchange rate has little direct impact on individuals. For consumers, what matters more is the purchasing power of those dollars -- reflected by the Consumer Price Index.

While the exchange rate fluctuates in the short term based on recent events and forecasts, the longer-term trajectory is mainly dictated by monetary policy, which in turn affects inflation. In the U.S., for instance, the Federal Reserve uses interest rates and other measures to control inflation and stimulate economic growth. Countries that keep inflation in check and have a growing economy are seen as having a successful monetary policy.

"In the short run, (a weak dollar) can signal all sorts of things, like expected weakness in the economy and lots of speculative things," says Mark Thoma, professor of economics at the University of Oregon. "But if you look at the longer trend, it's based mainly upon the monetary policies in the pair of countries you're examining."

Thoma says a falling dollar signifies, in the long run, that the U.S. has a slightly higher inflation rate than the rival country.

Weak vs. strong dollar

Theoretically at least, a weak dollar is better for an economy coming out of a recession while a stronger dollar is better for individuals.

A strong dollar gives Americans more purchasing power in the global marketplace. A weak dollar, on the other hand, can be better for the gross domestic product by making exports cheaper.

"The key is to make a distinction between impact on GDP, which is important in getting out of a recession, and standard of living, which is of paramount interest in normal times," says Bob McTeer, former president of the Federal Reserve Bank of Dallas and distinguished fellow at the National Center for Policy Analysis. "A weaker dollar will stimulate GDP by encouraging exports and discouraging imports."

According to McTeer, a weakening dollar should have the effect of reducing the trade deficit. That hasn't happened, ironically, because the dollar has not been able to deteriorate enough. Countries like China peg their currencies to the U.S. dollar, so those trade patterns tend to be somewhat insulated from fluctuations in the dollar.

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But there's another problem: The U.S. is generally not a producer of cheap consumer goods, so it can't compete with countries that have cut-rate labor forces and a willingness to devalue their currency indefinitely.

Here are three ways a weak dollar can make you poor:

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