Tag Archives: exchange rate

Neil Irwin notes that the “soaring dollar” is sign enough that the American economy is recovering:

In short, the U.S. economy is looking a bit better. And the other world economies are sucking wind. Just today, new data from the European Union showed that  in the 17 countries that use the euro currency, employment fell to its lowest level in seven years in the final months of 2012. In other words, things are even worse for workers in Europe than they were in the immediate aftermath of the 2008 crisis. […]

In other words, as terrible as the economy here may feel, it could be a lot worse. And importantly, while government policies (particularly by central banks) certainly have a lot of power to influence exchange rates, the core reality is this: The value or the dollar or any other currency hinges on the economic outlook for the country that uses it.

Dean Baker begs to differ:

The only serious way to get the trade deficit down is get the dollar down. That will make our exports cheaper to people living in other countries and make imports more expensive for people in the United States. That means more exports and fewer imports, and therefore a smaller trade deficit. (For those folks who were looking to the trade agreements, the idea that these will reduce the trade deficit is just something that the Serious People tell to children.)

Anyhow, it is easy to show there is no direct relationship between the health of the economy and the strength of the dollar. In fact, the recovery in the first half of the Clinton administration was based to a substantial extent on the idea that a lower deficit would lead to a lower valued dollar and therefore more net exports. And, this largely worked as shown below.

Other things equal, for a country that’s not price-inelastic on trade (technically, if the Marshall-Lerner condition is satisfied) I’d support a weaker currency. This generally benefits the disadvantaged who, in theory, would be more employable in traditionally blue-collar jobs like manufacturing and low-end services. It hurts the people who have much wealth in dollars, but that increasingly excludes the poor, and even middle-class.

But, it’s too simplistic to assume that what we need right now is a weaker currency, or that traditional devaluation (err, “depreciation”) will increase exports. Take, for example, this graph of our exports to China:


This graph shows that after the recession ended, both exports to China and the dollar increased with each other. This isn’t to say that there’s a causal relationship, indeed theory would suggest just the opposite. But does indicate that simplistic devaluations need have no effect. So just as Dean says “it is easy to show there is no direct relationship between the health of the economy and the strength of the dollar”, it is easy to show there is no direct relationship between net exports (which haven’t changed much in the past five years) and the dollar.

There’s also a pretty important problem with significantly devaluing the dollar. The world would be very angry with us. The world operates on a dollar-standard and countries pay for the most important import (oil) with the greenback. This means that countries keep dollars so that they can keep their energy sources flowing, and it also means that many nations have much of their wealth in dollars.

We would be ceding a key, global presence if our economy couldn’t survive without a weaker currency (recent job reports and sales show that this just isn’t the case). 

Indeed, a rise in the dollar implies an increased demand for dollar-denominated purchases, i.e. American exports. As several large multinational corporations signal a shift in manufacturing presence back to the United States, while still others plan on starting operations anew, it’s clear the world expects a growing demand for American exports. The value of the dollar is as much about market expectations regarding the American economy, as it is about the American economy itself.

Exchange rates, however, are also limited in the information they provide about an economy. For floating currencies, as the demand for exports increases the currency gains value. Eventually, the increased value results in a decreasing demand for exports. Indeed, between any two freely-trading nations, the exchange rates automatically adjust to create a standard equilibrium. 

Of course, the world is neither that simple nor predictable, but principally the same. Neil also recognizes this, I’ll finish with him:

At times, the tendency to conflate the strength or weakness of a currency with the strength or weakness of the nation is problematic. It can lead to bad policy if, for example, policymakers in a country with a terrible economic situation are unwilling to take steps to help because they fear allowing their currency to decline.

But strip out that emotionalism, and this teaches a fundamental lesson for policymakers: If you take care of your country’s economic prospects, the value of your currency will take care of itself.

So, contra Dean, I don’t believe that a rising dollar is a bad thing, per se. I certainly don’t believe devaluation sends the right message. And, when Dean says:

Anyhow, it is easy to show there is no direct relationship between the health of the economy and the strength of the dollar.

He knows that if the correlation doesn’t hold in the upward-direction, it definitely doesn’t on the way down, either. So if one can’t prescribe policy recommending a stronger dollar citing no correlation, then we certainly can’t recommend a weaker dollar, either. In this case, we let it be, laissez-faire