Mon, Mar 20, 2017 - Page 7 News List

Strong US dollar is not that great for US’ interests

By Noah Smith  /  Bloomberg View

Perhaps no other piece of economics jargon has caused as much confusion as the term “strong US dollar.” The phrase suggests patriotic strength, of the US riding roughshod over its economic rivals.

In reality, US dollar strength just means purchasing power — a stronger dollar lets US residents and businesses buy more things from overseas, while a weaker US dollar helps them sell more things to overseas customers.

If what you want is to sell more exports, weakness is strength.

Lots of people debate the question of whether the US should pursue a stronger US dollar or weaker one, or whether it matters. US President Donald Trump himself is reportedly unclear on the topic, and I cannot blame him. It is a very difficult one.

Pursuing a stronger US dollar means that the US wants to buy more things, while pursuing a weaker US dollar means that it wants to sell more things.

The US buys a lot more than it sells. This means that foreigners are accumulating the US’ financial liabilities. They hold US dollars, US government bonds and the like. If they want, they can redeem those for US-made goods and services. The trade deficit is therefore a way for the US to consume and invest more today, at the expense of future investment and consumption.

If the US were borrowing from overseas to invest at home, as many developing countries do, this would not be worrying — more investment today means a richer country tomorrow.

However, this does not appear to be what is happening. In the 1990s and early 2000s, the US was investing a historically normal fraction of its gross GDP.

However, this decade, the trade deficit remains high, while investment is much lower than normal. That trend is a bit worrying, since it means the country is living beyond not just its current means, but its future means as well — without more robust domestic investment today, the trade surpluses needed to pay back foreign debts in the future will be harder to bear.

There will also be the temptation to inflate away the debt — inflation constitutes a partial default on debt — which, if it got out of control, would be an economic disaster.

So US leaders do have some reason to want to reduce or eliminate the US trade deficit. The question is whether weakening the US dollar is a good way to do that.

Since the US does not have capital controls that limit the movement of money in and out of the country, weakening the US dollar would mean getting the US Federal Reserve to lower interest rates. Right now it is doing the opposite.

Howver, if the Fed decided a weaker US dollar was in order, it could stop tightening. If the past few years are any guide, the risk of causing inflation by keeping rates low would probably not be that big. The real cost of targeting exchange rates would mean that the Fed would surrender a lot of its power to use monetary policy to stabilize the domestic economy.

There is also the question of whether a weaker US dollar would even do much to change the trade balance. These days, US exporters are also big importers; instead of vertically integrated domestic producers, they are just one link in a global supply chain. A weaker US dollar would help their sales, but also raise their costs, as the price of their imported components and materials went up.

That is why a 2014 paper by Mary Amiti, Oleg Itskhoki and Jozef Konings found that exchange-rate movements were not very effective at altering the trade balance in recent years. This supports the findings of earlier research: Currency depreciations just do not pack the economic punch they used to.

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