Dollar Decline vs. Dollar Collapse

Dollar Decline vs. Dollar Collapse

Why a dollar decline is inevitable, and a collapse is unimaginable

By Kimberly Amadeo     Updated on May 18, 2022

The U.S. dollar declines when the dollar's value is lower compared to other currencies in the foreign exchange market. This manifests itself as a decline in the dollar index. Generally, this means a foreign currency, such as the euro, can buy an increasingly large amount of dollars.

A declining dollar can also mean a fall in the value of U.S. Treasurys, which drives up Treasury yields and interest rates. Treasury note yields are the main driver of mortgage rates. It can mean that foreign central banks and sovereign wealth funds are holding fewer dollars, too. This lowers the demand for dollars.

Economic Effects of a Declining Dollar

A weaker dollar buys less in foreign goods. This increases the price of imports, contributing to inflation. As the dollar weakens, investors in the benchmark 10-year Treasury and other bonds sell their dollar-denominated holdings.

Contracts for oil and other commodities are usually denominated in dollars. As a result, historically, there has been an inverse relationship between the value of the dollar and commodities prices. Essentially, as the value of the dollar falls, the dollar-denominated prices of these commodities must rise to reflect their unchanged intrinsic value.

On the plus side, a weakening dollar helps U.S. exporters. Their goods will seem cheaper to international buyers. This boosts the United States’ economic growth, which attracts foreign investors to U.S. stocks. However, if enough investors leave the dollar for other currencies, this could cause a dollar collapse. This is largely a theoretical consideration. The probability of this development is extremely low, as discussed in the closing section of this piece.

Potential Causes of Dollar Decline

In 2010, the Foreign Account Tax Compliance Act required foreign banks and other financial institutions to disclose information regarding income and assets held by U.S. customers.1 Its goal is to root out wealthy U.S. taxpayers who are hiding money offshore on purpose.

Another aim of the law is to stop foreign banks from using tax evasion as a profitable line of business. Many people were worried that foreign banks would drop U.S. customers, to avoid compliance with the law, thereby pushing those banks away from dollar-denominated assets, which might lead to a decline in the dollar's value.

On October 16, 2013, China allowed British investors to pour $13.1 billion into its tightly restricted capital markets. This made London the first trading hub for the yuan outside of Asia. This is one way China is trying to encourage central banks to increase their holdings of the Chinese yuan. It is the biggest potential threat to the value of the dollar. China would like the yuan to replace the dollar as the world's reserve currency. Were that to happen, the dollar would lose value.

Since then, China has been devaluing the yuan against the dollar. It is doing so because its leaders are worried China's economy is growing too slowly. The devaluation objective is largely accomplished via the continual purchase of U.S. dollars by the Chinese central bank. Clearly, China’s actions have a significant impact on the value of the dollar.

Recent Declines in the Dollar's Value

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