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is being able to strike the right balance.

CURRENT SITUATION

Whilst part of the reason for the current weakening of the dollar can be attributed to a number of the factors discussed previously, the position has been exacerbated by two further concerns, which are interrelated to some extent. The primary concern is the problems that have occurred within the US sub-prime mortgage market. Essentially this is the sector of the market that lends money to persons or organisations that have a less than perfect credit rating.

During the course of the past twelve months or so the level of defaults on these loans have been increasing, fuelling fears that the financial institutions would have to write off an significant amount of debt, a situation that has transpired. This position also means that there has been a reduction in the amount of capital available for prime lending, which has effectively led to what has become known as the "global credit crunch."

The reduction of capital brings about the second aspect of the current devaluation, this being a slowdown in the expansion of trade, as the corporations and government no longer have access to the necessary funds to enable them to undertake future expansion programmes. The knock-on effect is that the whole economy slows down, with the worst scenario being the potential for a recession. This would see further devaluation of the dollar as currency investors seek more secure economies in which to place their investments, such as Europe or the Far East.

The real task at this stage is for the government and central bank, in this case the Federal Reserve, to carefully manage a recovery programme. However, late January 2008 saw the Federal bank drastically cut interest rates in a gamble to stave off recessional pressures. The risk with this step is that it could lead to further dollar devaluation and the resultant increase in prices that this might generate. Time will tell whether this throw of the dice will work but with the current level of delicacy and nerves in the global financial markets, it does not look promising.

Learn more about this author, Paul Lines.
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