How can a weak dollar be beneficial?

by on October 22, 2009 at 10:04 am in Economics | Permalink

I'm still receiving email pushback on my view that a falling dollar can be good for the U.S. economy.  The critics charge: why not just let the dollar fall close to zero or at least hope for such?  A few points:

1. I'm not asking for a specific weak dollar policy (we've already done enough on that front!).  The point is that if the market brings a falling dollar, this outcome can be part of the equilibrating process.

2. You don't have to approve of all the policies, or private sector practices (e.g., a low savings rate) that produced the weak dollar.  A weak dollar is still a healthy response, given those constraints.

3. Never forget the difference between real and nominal exchange rates.  That answers the conundrum about wishing for a dollar of near-zero value. 

4. A falling dollar will (often, not always) increase employment in the export sector.  Supply-side, production-based multipliers are the best kind to have and they can outweigh the economic costs of higher import prices.  When the dollar falls, a big chunk of that shift is born by foreign exporters like a tax rather than being passed along to U.S. consumers.  The net effect is that Mercedes-Benz subsidizes job creation in the United States.  And sometimes a falling currency is in fact an efficient form of lump sum taxation in this regard.

5. Free traders are usually economic cosmopolitans, which is good.  A weak currency in one country means a strong currency in another and the distribution effect, at least at the first-order level of analysis, is a wash.  So cosmopolitanites shouldn't object to weak currencies per se.  From a global point of view, a lot of currency movements are close to a net wash in efficiency terms, although they may be good for at least one of the countries in the equation.  As a rough rule, weak currencies do the most good where resources are unemployed and there is a realistic elasticity of exports, though it is more complicated than that.

6. A weak dollar poses the biggest problems for the EU and other foreign regions.  Still you can see those as real problems and think a falling dollar is OK for the U.S., taken alone.

7. Again: blah-blah-blah caveats about the difference between a currency falling as a pure thought experiment and a currency falling as associated with some particular cause.  Blah, blah, blah, etc.  Blah.

Daniel Drezner offers related commentary.

1 D. Watson October 22, 2009 at 10:26 am

I disagree vehemently with point 7. Blither blither blather, ditto ditto. Except in the case where blather garble needless pedantry. So there!
(Thank you for your sense of humor. It is delicious throughout.)

2 Brian J October 22, 2009 at 11:17 am

Maybe the solution is to call it something else entirely, like the “strong export, positive job creation dollar.”

3 Andrew October 22, 2009 at 11:39 am

Are exports at the expense of internal division of labor? Don’t you have to know if the dollar should be lower? Doesn’t that imply you have a target and will know when we’ve gone past it? Don’t you need to have a view on what our export levels should be? If not, then it will fall (especially with active encouragement), only to rise only to create an export bubble and future recalculation (and pain). I’m not sure how you can be sure that just because we have a trade imbalance that it should be balanced with the current mix of goods. China will eventually want to buy our stuff, but maybe not right now. Or, it doesn’t matter and the imbalance itself is the evil to be addressed. I tend to think that it is modulated by the interest of the decision-makers and not so much the general welfare. Could they fight it if they wanted to? Or is it just a matter of acceptance and serenity?

All that said, the solution is obvious. Stop checking your e-mail.

4 Sigve Indregard October 22, 2009 at 12:00 pm

I’m just saying “Yay” and order tons of books from amazon.com. The dollar has fallen more than 23 % against my local currency, the Norwegian krone — from its March peak at 7.22 to today’s 5.54. That’s great for me.

And I guess it goes for anecdotal evidence in favor of your point no. 4.

5 wlu2009 October 22, 2009 at 12:32 pm

“I hold US dollars; therefore a weak dollar is a bad thing. QED ”

Only if you are prodigious consumer of imported goods over domestically produced ones. Remember the dollar isn’t falling relative to goods and services (that would be inflation), but relative to other currencies. Since domestic prices are basically flat, a falling dollar hits you only if you buy a lot of imports. What’s more, if you work for an industry that exports its goods and services, a falling dollar makes your product cheaper to consumers, increasing sales. Try to actually READ the agrument rather than distill it to a seemingly simple but factually innacurate string of words next time.

6 Vehical Driver October 22, 2009 at 1:02 pm

Do you envy the Indian professional in India who earns $500 for a month of his full-time labor?

I know Indians that make less than my income, yet live in big houses with servants, have a chef that prepare them delicious food, and generally live a higher standard of living than most Americans or Europeans. I envy their lifestyle, sure. The only drawback seems to me they can’t afford imported luxury goods.

The problem with India isn’t the poorly paid (by our standard) professionals… it is that only a tiny fortunate minority fall into the Indian professional class. If the U.S. becoming Germany’s Mexico increases the standard of living of Americans, why not?

7 jorod October 22, 2009 at 1:13 pm

A weak dollar implies higher prices. That means lower real income. Which means a lower living standard.

8 Laserlight October 22, 2009 at 1:30 pm

“A weak dollar implies higher prices”. That turns out not to be the case. A weak dollar implies we pay higher prices **for imports**. It also implies that we can either *charge* higher prices for *exports*, or keep the same price to sell a greater volume, or some combination. Weak dollar doesn’t affect domestic sales.

“There are no stupid questions”, but any economics statement which a medieval literature major can instantly refute …

9 Tony October 22, 2009 at 1:37 pm

Also… the dollar is weakening against the yen and the euro but it is NOT weakening against the Chinese yuan, critically. Until the yuan is allowed to appreciate nothing will happen.

10 RP October 22, 2009 at 2:06 pm

How well could AI predict moral hazard?

The S&P 500 Index is now selling at 26 times operating earnings. (more than at the five year bull market top in 2007)

Official debt is $11.95 trillion, $150 billion below the debt ceiling.

While 7000 people lose unemployment benefits daily, the Senate delays extending benefits in an effort to finance them with bailout funds — at the sime time they debate the debt ceiling issue.

Could these be the experimental conditions that reveal fundamental weaknesses in models such as the FHFA House Price Index whose 2nd largest contributing factor is (in todays’ report) consumer expectations?

How much of the consumer expectation factor is influenced by the model’s treatment of relative improvement in jobless claims, stock prices, and supplier delivery responsiveness?

How much of the consumer expectation factor is influenced by the model’s treatment of the relative decrease in the manufacturing workweek and the dip in building permits?

In the future will these models use related external data (particularly data indicating bubble potential) to establish paramaters that will inform their own bubble potential prediction axioms?

Will the model be able to predict when consumer expectations become irrational?

For the model to accurately predict these distortions, would it need to include data such as dollar volume of stock market trade versus capital value?

Will measuring relative trade volume involve evaluating the computer models used by investors to drive high volume trading?

Will the predictive accuracy of the index hinge on effective methods of evaluating the predictive power of algorithms developed for investors by humans, artificial intelligence, and combinations of the two?

Is this one of the paths being cleared by the bayesian revolution?

Will improved indices lead to more defined, easier to predict W’s, or will they improve markets?

11 wlu2009 October 22, 2009 at 2:13 pm

Spencer,

You are making a few incorrect assumptions. Brokerage houses make money on currency spreads. That is, they execute trades for clients by selling at a higher price than they buy. Most of the money made is not from takign proprietary positons in currency.

Also, i don’t know the number but I would venture that currency hedging by international firms is probably the a huge component if not most of all currency trades. GM sells cars in China, needs to convert its yuan to dollars, and needs to engage in a forward sale of yuan to hedge fluctuations. Hundreds of thousands of companies are doing this daily, that is a huge volume of trade, and probably the biggest motivation in the currency market.

12 Nylund October 22, 2009 at 2:46 pm

“A weak dollar implies higher prices. That means lower real income. Which means a lower living standard.”

I count three mistakes in logic in these three sentences.

1. “A weak dollar implies higher prices” – At the moment, domestic prices are not increasing. This would make the imports more expensive so it this would only be true if your purchases are dominated by imports.

2. “That means lower real income” – Well, if #1 is wrong, then obviously #2 doesn’t follow. If you are an exporter (eg. work for a company that sells products overseas), but buy domestically, your real income would increase.

3. “Which means a lower living standard.” If #1 and #2 are wrong, then #3 does not follow. EG China. Their artificially low-valued currency has led to an increase in their living standards as they are net-exporters.

——

“This is ridiculous. Obviously a correctly valued currency is optimal, it should be neither undervalued nor overvalued.”

But what is “a correctly valued currency”? The value determined by the market? The value that leads to balanced trade? And couldn’t this be subjective? The American commenter purchasing a foreign camcorder might have a different answer compared to Americans who benefit from that foreigner commenter buying more American books on Amazon.

Overall this strikes me as a meaningless statement – “it is neither too big, or too small.” Well, duh, but that doesn’t really pin things down very well, now does it?

13 Anonymous Coward October 22, 2009 at 3:10 pm

This is stupid, it matters not the value of the dollar or the other currency. What matters is the first derivative of the value, because of price stickiness.

Money is fungible so the actual value doesn’t really matter, just the changes in value, because of lags in the economy,

14 RP October 22, 2009 at 3:25 pm

Will future economists blog while legislators debate how to implement software into CFPA regulatory procedures which will put pressure on moral hazard while simultaneously red flagging evidence that trading software developed by company X — designed with the intention of offering proof of a theorm such as the Elliot Wave principal — has successfully done so through unfair market manipulation?

Will this software, protected by US (or perhaps UN) copyright, present a paradox for the judicial system?

15 wlu2009 October 22, 2009 at 4:29 pm

@ Anonymous Coward

Completely wrong. If an imported good, say French wine, which is denominated in Euros, costs 20 Euro today, and tomorrow cost the same 20 Euro, but the dollar has depreciated by 20%, the wine will cost me 20% more to purchse. The winemaker cares not about the exchange rate, but only cares about how many Euros he gets, and since it now IMMEDIATELY costs me more $ to get the same Euros, the price has gone up, irrespective of any stikiness. It works backwards with imports. FX has an immediate impact on prices.

16 Dan October 22, 2009 at 4:48 pm

The way I see it, the problem isn’t the steady-state level of the U.S. dollar with respect to other currencies – a floating exchange rate is on balance a good thing, and having the dollar adjust to economic reality is what you want.

However, the problem is in the transitional phase. The U.S. is a net importer of goods, and maintains a large trade deficit. The falling dollar will correct this – imports become more expensive relative to domestic goods, and exports become more valuable. But the transition will be painful. Consumer prices will go up before the export market can grow. The larger impact of import prices as compared to export prices means a net loss until the economy restructures.

In the meantime, wouldn’t there be an effect similar to inflation on the informational value of prices? If prices fluctuate not on quality, but on the relative percentage of imported intermediate goods in a product, then it will be harder to make rational decisions based on price until some time has passed and the market adjusts.

17 anon October 22, 2009 at 7:08 pm

A lot of commenters are misunderstanding what Tyler said. What Tyler is saying is that depreciation is not good or bad ceteris paribus. However, the impact of a depreciating dollar on import/export prices will show up in the inflation rate, which may be bad.

18 DanC October 22, 2009 at 11:03 pm

A dropping dollar will help exports. This is good for exporters. However the cost of imported commodities, especially oil will increase. This is will be like a big tax on the economy. Which will dominate is unclear at this point in time. Especially if the Federal government is increasing taxes and regulations at the same time.

In addition, will other countries continue to buy our growing debt, and dropping dollar, without a compensating increase in interest rates. And how will that increase in interest rates affect growth potential.

Future doesn’t look that bright.

19 babar October 23, 2009 at 10:56 am

the main reason to want a weaker dollar is that it could mitigate imbalances which might cause major problems later.

20 anon October 23, 2009 at 2:48 pm

It is also my understanding that inflation is primarily a result of monetary policy.

Inflation may be strictly speaking a result of monetary policy, but what that means is that the Fed has to tighten interest rates in order to offset the effects of increasing import/export prices, and that’s just as bad.

21 Aliaksandr Kikoin October 25, 2009 at 2:18 am

I think there is an advantage in every situation. Having a weak currency does not necessarily mean to have just the negative effect on the economy. Market tends to go towards equilibrium.
Even in a situation with a weak dollar, USA has several scenarios it can benefit from. First thing that I would want to mention is trade. According to http://www.census.gov/foreign-trade/index.html “the Nation’s international trade deficit decreased to $30.7 billion in August from $31.9 billion (revised) in July, as exports increased and imports decreased.(October 9, 2009)”. So there, it does help domestic industry, if not to create trade surplus, but at least reduce trade deficit. Creating extra jobs in the export production sector might be a possibility as well.
Second thing – tourism. Overall visitation from around the world to the United States declined this year because of global downturn, but because of a weak dollar our country might become more attractive.

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