Two perspectives on the American dollar

Shortly I am headed back from Poland to France, for one more day in Europe. I cannot help but wince at the especially high prices in France, compared to the United States. You may recall my mention of the five dollar chocolate bar; at home I could get the same for less than three dollars.

So a microeconomist might conclude that the U.S. dollar should rise over time. Arbitrage will cause people to buy more in the United States, helping out the dollar.

Or look at interest rates. You can pick and choose various comparisons, but overall they are not bearish for the dollar. That is investors do not expect the dollar to fall. Nominal interest rates on the dollar are low, but people are still holding dollars. So those investors presumably expect the dollar to appreciate.

Let’s bring the macroeconomist into the picture. He tells us that the United States has unsustainably high trade and budget deficits. The only way to clear these deficits, he says, is for the dollar to fall at least thirty percent. We will sell more exports, our trade balance will be restored, and our consumption binge will be checked. Long-run accounts will balance.

Could the macroeconomist be wrong? After all, someone has to be wrong.

If we are comparing the dollar and the Euro, I wonder whether the U.S. is really in a deficit position, all things considered. Even if our measured fiscal position is poorer (this depends who you compare us to), isn’t the American economic future brighter? We have better demographics, a more entrepreneurial culture, and arguably a more robust ability to reform and regenerate ourselves. The optimism of a population counts, though it doesn’t fully reveal itself on this year’s balance sheets.

So will the dollar rise or fall? Should we believe the microeconomists or the macroeconomists?

The nice thing about economics, of course, is that someday we will know. The problem with economics, of course, is that we don’t know now.

For an overview, here is a simple essay by Hal Varian on exchange rates. Niall Ferguson, a dollar pessimist, offers political commentary.

I am indebted to conversations with John Nye for some of the ideas in this post.


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