I am dared to believe the dollar is undervalued

Paul Krugman writing in Economic Policy estimates that at a real dollar depreciation rate of 2% per year the US is headed for a steady-state capital-account position of -15 months’ GDP, and that at a rate of 4% per year is headed for -7 months’ GDP. Yet foreigners–both private and central bank–are not demanding any yield premium on US assets.

This worries him, very much: situations in which large numbers of speculators, investors, and financiers hold irrational expectations are situations that could rapidly move southward overnight should reality intrude into the mind of the capital market.

Link here.  I know full well that in most sensible intertemporal models the U.S. dollar is overvalued and must fall further to set right the trade balance.  But these same intertemporal models don’t explain business cycles or unemployment very well (they do at times, but that’s it), so why should they explain currency values?  Nor do these same macro models command the full loyalty of Krugman and other pessimists in different settings.

I do know that purchasing power parity predicts long swings in exchange rates to some crude extent, and right now I’m dead set against family summer vacation in Europe.  So I will accept this dare and assert that the U.S. dollar is undervalued in world currency markets.


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