During the first six months of 1995, the U.S. dollar rebounded from 80 yen and 1.35 deutsche marks to approximately 100 yen and 1.42 D-marks. (Levy, 1995). Yet despite this recent rise, dollar weakness overall has accelerated during the past few years. Even so, many commentators and investors continue to believe that the outlook for the dollar is promising, or to put it more bluntly, that long positions in the dollar will eventually be rewarded (Los Angeles Times, October 6, 1994). Part of the reason for this optimism is the failure to grasp the real issues underlying the dollar weakness (See Table 1).
At the end of World War II, the dollar was considered the world's reserve currency. It was made convertible into gold at $35 to the ounce, and other currencies were made convertible to the dollar (if not right away, then eventually). At first, there were not enough dollars to go around, but by the mid-1950s, however, there was a great and growing surplus. The glut of dollars has persisted on and off to this day (Moffit, 1983).
In the 1960s, the U.S. dollar weakened dramatically as a flood of U.S. direct investment poured into Europe. In effect, the long-term capital outflows exceeded the sizeable U.S. trade surplus that then existed. By 1971, this imbalance had wrecked the Bretton-Woods system of fixed exchange rates. Once currencies began floating in the early 1970s, the dollar quickly sank due to a growing U.S. current-account deficit - though still modest - and a near full-fledged capital flight as American political and economic ills mounted (Grants, 1992).
Most commentaries on the dollar's problems have ignored, or overlooked, the simple words "balance of payments deficit." It is here that a major reason for accelerating dollar weakness can be found. The last significant U.S. balance of payments problem was in 1987, some time after the 1985 Plaza agreement to secure further depreciation. Then the U.S. curr...