MENU
 Registered users can save articles to their personal articles list. Login here or sign up here
 Registered users can save articles to their personal articles list. Login here or sign up here

The strong dollar isn’t that great for America

When the currency gains, US exports become less competitive and imports become cheaper.

Perhaps no other piece of economics jargon has caused as much confusion as the term “strong dollar.” The phrase suggests patriotic strength, of the USA riding roughshod over its economic rivals. In reality, dollar strength just means purchasing power — a stronger dollar lets US residents and businesses buy more things from overseas, while a weaker 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 dollar or weaker one, or whether it matters. President Donald Trump himself is reportedly unclear on the topic, and I can’t blame him. It’s a very difficult one.

Pursuing a stronger dollar means that the US wants to buy more things, while pursuing a weaker dollar means that it wants to sell more things. The US now buys a lot more than it sells: 

This means that foreigners are accumulating the US’s financial liabilities. They hold 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 wouldn’t be worrying — more investment today means a richer country tomorrow. But this doesn’t appear to be what’s happening. In the 1990s and early 2000s, the US was investing a historically normal fraction of its gross domestic product. This decade, however, 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. That could be a difficult adjustment for Americans in the future to bear, and could even lead to political unrest. 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 dollar is a good way to do that.

Since the US doesn’t have capital controls that limit the movement of money in and out of the country, weakening the dollar would mean getting the Federal Reserve to lower interest rates. Right now it’s doing the opposite. But if the Fed decided a weaker 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 stabilise the domestic economy.

There’s also the question of whether a weaker 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 dollar would help their sales, but also raise their costs, as the price of their imported components and materials went up. 

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

An alternative policy is the border adjustment tax now being considered by Congress, which would lower taxes on exporters and raise them on importers. That would help crack down on tax havens and reduce the amount companies waste on tax avoidance. Yet its impact on the trade deficit might be muted, for the same reason described above — big exporters are also big importers.

These strategies might be worth trying, but in the long run, the best way to eliminate the trade deficit might be to encourage American individuals to save more and American companies to invest more. That wouldn’t just reduce the trade deficit; it would also leave behind a richer economy for future generations.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

© 2017 Bloomberg

Looking for a financial education solution for your staff?

  • This field is for validation purposes and should be left unchanged.
   No comments so far

To comment, you must be registered and logged in.

LOGIN HERE

Don't have an account?
Sign up here

Latest Currencies

ZAR / USD
ZAR / GBP
ZAR / Euro

MONEYWEB NEWSLETTERS

Subscribe to our mailing list

* indicates required
Moneyweb newsletters

Podcasts

Moneyweb Investor Issue 24

The relative strength of the rand has seen South Africans relax since the cabinet reshuffle and sovereign downgrades by S&P and Fitch. Don't be deceived - this is a self-inflicted wound. In the May issue of The Moneyweb Investor, we take a closer look to see which companies are likely to thrive and which will not, in the post-downgrade world.

Follow us:

Search Articles:Advanced Search
Click a Company:
server: 172.16.0.14