Thursday, December 18, 2008


Currency issues are confusing to Americans. Most of use live and think in dollars, believing that currency fluctuations don’t matter. As this week’s headlines remind us, life’s not that simple. The terminology itself is part of the problem. Subliminally, “strong” registers better than weak.” But does it help or hurt the American economy when the dollar strengthens as it had for several months? Does it help or hurt the American economy when the dollar tumbles as it has in the past few days and weeks, wiping out months of “gains” in value? In both cases, the answer is: both. Mixed blessings are by the same token mixed curses.

A stronger dollar raises the price of US exports in terms of freely traded foreign currencies. Over time, that reduces our access to foreign markets. It also tends to lower the dollar price of imports, adding to our deficit. At the same time, a stronger dollar tends to lower the price of imported oil and gas and is more attractive to foreign suppliers of capital. It reduces inflationary and can spur deflationary pressures.

By contrast, a weaker dollar lowers the price of US exports and raises the price of our imports, reducing our trade deficit and the need to borrow to finance it. At the same time, it tends to raise the price of oil and gas imports and prompts foreign suppliers of capital to park their cash in some other currency.

So, it should be clear that any gains from dollar movements: 1) are accompanied by losses in other parts of our economic life; 2) are temporary and subject to reversal, perhaps even in the short-run; and 3) cannot be relied upon to solve our long-term competitive problems. (Mercantilist currency policies, a pet policy peeve of mine, are simply price-fixing schemes that subvert the working of free markets, thwarting the short-term adjustment function of exchange rates.)

To achieve lasting competitive gains, we need smart policies in all the areas that impact our trade performance. The on-going recovery and rescue packages under consideration are our best opportunity to get some of that right. If we don’t, we’re just wasting trillions of dollars that we’ll be unable to repay – a recipe for massive inflation.

In my next post, I’ll advance one simple idea for getting it right, starting immediately, without any up-front government expenditure, and in a way that maximizes reliance on market forces.

Charles Blum

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