Monday, May 23, 2011

What is Wrong with a Weak Dollar?

Nothing, if you ask me - in fact it is the natural equilibration mechanism of the world economy and right now the very weak dollar is helping make US exports competitive abroad.  Brazil, right now, faces the opposite problem, the Real is so strong (thanks in large measure to the boom in commodities prices) that it is getting harder for Brazilian exporters to compete.  My experience in flying to São Paulo last fall was a flight from Chicago stuffed with Brazilians and their many purchases from US stores, while the flight home was somber - many Americans broke from a short stay in the metropolis.

Brazil faces troubling inflation and sagging exports.  The response to the former - tighter monetary policy - will increase interest rates and further the appreciation of the Real.  Both will slow down economic growth.  In the US, a weaker dollar and very low inflation will help speed the tepid recovery and keep a lit on imports as consumers will be daunted by their high prices.

But none of this is well understood among the average US worker, and perhaps the governments reluctance to talk openly about it is the culprit.

In the New York Times this weekend, Christy Romer argues that the government should speak more frankly about exchange rates and how they affect the economy:

Some countries, like China, essentially fix the price of their currency. But since the early 1970s, the United States has let the dollar’s value move in response to changes in the supply and demand of dollars in the foreign exchange market. The Treasury no more determines the price of the dollar than the Department of Energy determines the price of gasoline. Both departments have a small reserve that they can use to combat market instability, but neither has the resources or the mandate to hold the relevant price away from its market equilibrium value for very long.


...Perhaps if government officials could talk about the exchange rate forthrightly, there would be more understanding of the issues and more rational policy discussions.

Such discussions would start with some basic economics. The desire to trade with other countries or invest in them is what gives rise to the market for foreign exchange. You need euros to travel in Spain or to buy a German government bond, so you need a way to exchange currencies.

The supply of dollars to the foreign exchange market comes from Americans who want to buy goods, services or assets from abroad. The demand for dollars comes from foreigners who want to buy from the United States.

Anything that increases the demand for dollars or reduces the supply drives up the dollar’s price. Anything that lowers the demand for dollars or raises the supply causes the dollar to weaken.


But in a depressed economy, it isn’t so clear that a strong dollar is desirable. A weaker dollar means that our goods are cheaper relative to foreign goods. That stimulates our exports and reduces our imports. Higher net exports raise domestic production and employment. Foreign goods are more expensive, but more Americans are working. Given the desperate need for jobs, on net we are almost surely better off with a weaker dollar for a while.

I encourage you to read the entire essay at the Times. For other coverage of the benefits of a weak dollar, here is the Planet Money folks at NPR (oh how I hope NPR will move away from the folksy economics coverage) and USA Today.

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