Wild card: oil's price

Independent currency trader Andrew Resnick, formerly of Next Capital of New York, has a more-cautious view of the dollar's 2008 prospects.

Resnick remains concerned that investment flows into the United States will not remain robust enough to support a strong dollar rally. A likely slowing U.S. economy, combined with the investor nervousness following subprime mortgage and related asset defaults, will temper foreign demand for U.S. investments. Another unknown variable, in Resnick's interpretation, remains the price of oil.

"If oil drops to $75-80 per barrel, that would offset some of the consequences of the housing sector's correction, and would even give the [U.S.] economy a little bit of a boost, but there's conflicting data on where oil's heading in 2008," Resnick said. "Some model projections show oil moderating to around $80, but then there are other research reports that predict no big decline in oil's price. If oil doesn't drop, the transfer of wealth out of the U.S. to pay for imported oil will offset export gains elsewhere, which will make it harder for the dollar to rally." Oil rose $1.49 to $97.46 in Thursday afternoon trading.

Resnick expects the dollar in 2008 to improve modestly against the euro, to $1.35, and to $1.90 against the British pound. He also expects the dollar to maintain current levels against Japan's yen, or trade at about 115 yen by the end of 2008.

ECB effect

Another unknown variable in the dollar value equation is the European Central Bank, according to economist Steve Affinito.

Affinito noted that there have been a series of signs that the European Central Bank is becoming less enamored with the the euro's lofty level. As the euro rises vs. the dollar, European goods become more expensive to consumers with dollars, making them less attractive to these consumers, all other factors being equal. Affinito sided with other economists and analysts who view ECB President Jean-Claude Trichet's recent comment that he is against "brutal moves" in the currency markets as a signal by the ECB that it believes there are limits regarding the euro's upward move vs. the dollar, rhetoric regarding market forces notwithstanding.

"So far the ECB's deeds have not matched their words, but one gets the sense the ECB will take actions to strengthen the dollar and weaken the euro in 2008," Affinito said. "Of course if the euro-zone economy slows on slower U.S. growth, the ECB will cite a need to stimulate its economy in any interest rate cut, but you get the sense that if European companies continue to see exports hurt by the euro, the ECB may lower interest rates to weaken the euro and strengthen the dollar."

In particular, Affinito said Airbus -- engaged in a global contest with Boeing (NYSE: BA) not only for commercial jetliner orders, but, analysts say, for which company's philosophy will define air travel in the early 21st century - - will play a role in the ECB's decision. Airbus sells its planes in dollars but about half its costs are in euros, which makes the company sensitive to a rise in the euro vs. the dollar, despite the company's hedging efforts, Affinito said.

If Airbus cites the euro's high value as a major factor in its ability to compete with Boeing on a price basis, that would weigh on the ECB, in Affinito's interpretation. "Airbus is already starting to complain about it," he said.

Europe's rising trade deficit with China is another factor, Affinito said. The euro's rise vs. the dollar, combined with China's currency peg for the yuan, makes European goods even more expensive than U.S. goods vis-à-vis China's market.

"Just think in terms of the cost of U.S. goods, plus 30% or so. That's what Europe faces regarding exports to China," Affinito said. "That's not a pretty picture for Europe trade flows to China."

Big factor: U.S. GDP

Still, Affinito argued that the biggest factor regarding the dollar's status in 2008 will be the U.S. economy.

U.S. GDP growth of 2.0%-2.4% in 2008, which Affinito projects, should be enough to sustain a mild dollar rally.

"If the U.S. economy falls into a recession, of course that would be negative for the dollar," Affinito said. "But if the U.S. economy continues to muddle through this housing mess and achieve at least 2% growth, and I think it will, that should maintain the attractiveness of U.S. investments, and that's dollar positive. Now, an economy achieving 2% GDP growth doesn't sound like much, but after all that the U.S. economy has endured in 2007, we'll take it."