The US dollar has fallen precipitously in 2011.  The Dollar Index – which tracks the dollar’s value against a basket of currencies that includes the euro, yen, pound, Canadian dollar, Swedish krona, and Swiss franc – has fallen to 75.07.

Now, it is poised to blow through the October 2010 low of 74.9 and down to the November 2009 low of 74.2.

The dollar’s decline in 2011 was driven by interest rate hikes or the expectations of them from European central banks.  A sharply divided Washington – which can’t seem to agree on budget deficit issues and come up with a credible medium-term plan for fiscal consolidation – also contributed to the decline.

The United States, however, may not mind.

It has long complained that other countries (namely those in Asia and Latin America) have undervalued currencies, which make US exports less competitive.

Now, as the dollar weakens, US exporters can expect to benefit and the US as a whole may export its way out of anemic economic growth.  Indeed, on the back of euro’s weakness in the first half of 2010, Germany’s economy boomed.

However, a weak dollar may not be all good news, especially considering the reasons for the decline in 2011.

If it reflects ultra-loose monetary policy, inflation may spiral out of control down the road.  If it reflects international concerns about the US federal budget deficit, the US government and private business will face higher costs of capital.

Both scenarios will weaken the US economy and competitiveness.

Finally, the ‘global currency war’ mentality may not have gone away.  If the US dollar falls further, don’t be surprised if other countries come up ways of devaluing their own currencies.

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