I have been reading reports about countries preparing to ditch the dollar as the reserve currency, especially for oil trades. As an American what will this mean to me? Why should I care?
I am not being flippant, just asking that you fight my ignorance!
If you are an American paid in dollars, your dollars relatie to the rest of the world buy less. All imported items become more expensive, including imported inputs of items made in the USA. In the short term, that will change faster than any increase in domestic production or US exports. You end up paying more. Services would be effected on a secondary basis.
*
(Where the Euro comment comes in escapes)*
In addition, if there was a massive switch away from use of US dollar (or put another way, demand for US dollars dropped significantly), the USA would face an immediate spike in domestic interest rates or it would not be able to issue new debt.
The USA benefits from a decline in US dollar that is gradual as it makes your exports more competitive. A sudden change however could very easily trigger a global economic crisis.
Overall, the U.S. does not benefit from a decline in the U.S. dollar, because the U.S. is a net importer of goods.
So one aspect of the decline of the dollar is the exchange rate issue. But the other issue is the dollar’s unique status as the world’s reserve currency. That has been valuable to the United States because it gives the dollar extra value, which in turn gives the U.S. an interest rate advantage. Simply put, when times are tough money flees to the dollar for security, and America charges a premium for that security. So America pays less in interest for its borrowing than others do.
This has been one reason why the U.S. has been able to maintain large current account deficits. If the U.S. loses its reserve currency status, its borrowing costs are going to go up, and the current account deficit is going to become a larger drag on the economy.
This is the danger of rapidly increasing the debt. There’s a double-whammy here in that the debt increases, which drives up interest costs, but if the debt destabilizes the dollar, then each additional dollar of debt makes all the previous dollars of debt more expensive to carry as well. That’s a real danger to the U.S. economy.
The bottom line is that the U.S. is going to have to find a way to dramatically reduce its trade deficit. That will happen naturally as the dollar falls, as the higher price of imports will reduce consumption of them in the U.S., whereas the exporters will have a bigger advantage because American products will be cheaper for the rest of the world. But it could very well mean a reduction in overall standard of living - goods will be more expensive, and wages will stagnate or even come down as more production is aimed at export markets, in competition with companies in other countries that have cheaper labor.
newscrasher, there’s another thread about OPEC and the dollar that pretty much covers this discussion. The best quick summary from the thread is a cite from E-Sabbath to this Time blog post.
This simply isn’t logical. Being a net importer of goods does not automatically mean that a strong dollar is beneficial. Being a net importer of goods can itself be a negative, which is offset by a declining dollar. In this sense, a declining dollar is simply the market reaching equilibrium to offset the trade imbalance. In point of fact, US manufacturing was undergoing a mini-Renaissance before the crisis caused the flight to quality, which strengthened the dollar again and undercut our exports during the worst stages of the recession. If the current dollar decline causes another set of gains in manufacturing, that would create many more jobs. You’re right that there’s a trade-off in place, especially with respect to higher prices for consumers, but when 10% of the labor force is out of work, getting wages moving again to people currently without income is going to be more important than the rising costs for imports (which will themselves have a salutory effect on domestic production, and thus job growth).
Now obviously, the dollar can’t drop forever. The current deficit situation is not sustainable. What’s good policy during a recession is not good policy during a recovery. Interest rates will eventually go up. Inflation will eventually creep up. The budget deficits will have to be brought under control. But at present, the weakening dollar is a good sign, and we are absolutely going to benefit from it in many ways, even with its future costs.
Of course, that could act as a de facto protective tariff, stimulating American industry (to supply the American end-use market; export trade is secondary). Certainly American industry could use some stimulating right now.
What it means to you (and me and most other American’s) is that the price of many goods and services will go up. We take for granted the low cost of many of the goods we buy every day (and decry places like WalMart that bring us those cheap goods), but if the world significantly shifts from the dollar, then prices here will go up for all manner of imported goods (like oil, for instance).
Why you should care is that in the short term at least it’s going to have a significant impact on our economy. If you are poor it’s going to be an especially hard blow, especially in the short term.
In the medium and possibly long term things will eventually balance out with, perhaps, local US manufacturing experiencing some modest growth, as some of our industries and manufacturing will become more competitive, especially in our own markets. I don’t believe this will be a net positive for the US, but eventually things will reach a new equilibrium and life will go on. It will sort of suck in the short term though, especially for the poorer folks.
The idea that a weaker currency per se damages the economy is nonsense. If that were true it would make sense for governments to intervene in the foreign exchange markets to boost their currency. Not only would this imply that flexible (i.e. market determined) exchange rates are bad, it is logically impossible to for all currencies to rise in value against each other. In the current context a weaker dollar is probably a net benefit to the US for reasons that Hellestal mentioned.
The distinct question of whether the US will remain the world’s reserve currency is another matter. Being a reserve currency has some benefits but they are fairly modest; I have seen estimates of 0.5% of GDP.Being a reserve currency doesn’t mean that you are insulated from oil price shocks as was fallaciously stated on another thread. And it does carry risks as well. One of the major sources of the current crisis was the dollar’s status as the world’s dominant reserve currency. When Asian central banks decided they wanted to increase their dollar reserves this helped create fundamental imbalances in the world economy with large trade and budget deficits in the US and huge capital flows which were largely diverted into the housing bubble. A more balanced global financial system with several reserve currencies including the dollar may well be more stable.
The current obsession with the dollar in right-wing circles is the usual ideologically and politically motivated charlatanry. There seems to be some implication that the fairly modest Obama stimulus is a major part of the problem which is not true. Furthermore the idea that the US government should act to strengthen the dollar by raising interest rates or reducing spending is a recipe for disaster and would probably be the best way of ensuring a double-dip recession. That would be pretty good for the political fortunes of the GOP but certainly not for anyone else.
The US consumer in the short term pays higher prices. As does most of industry given imported components.
US exporters, however, gain.
The US, in a transition scenario, will benefit after some short-term pain.
The interest item is a boon, but overall it has come at the price of extensive support to a strong dollar due to demand. That is a mixed blessing.
It may stimulate industry, I would not all it a “protective tarif” however.
And the US prospered as an importer as well. Free trade led to prosperity. The post WWII scenario was a unique one and not something that is repeatable. The US can’t work on a redo of 1950s-1960s.
heres a specific example. I run a small software business and at the moment even though I am based in Australia I fix my prices in US dollars.
That means that people that people that buy my products in other countries pay less or more depending on what the US dollar does while your price is fixed. I’m considering very soon changing my pricing to being based in Euros.
The US dollar has depreciated 30% against the AU dollar in the last year but I’ve kept my prices constant in US dollars. Lots of companies are doing this right now which means you US consumers are being artificially protected from the fall of your dollar.
When I, and many other international businesses, change our prices to being fixed in euros, or ounces of gold or some other measure as we have to inevitably do, then your prices for all imported products (eg most of them) are going to skyrocket.
First, the pedantic technical point: there’s no gain to be had from using a medium of exchange whose value is more volatile than the dollar. That means it gains nothing to price in any commodity, including ounces of gold. There is some sense in pricing in a stable currency, but only because it would decrease “menu costs”, the hassle of changing the actual nominal sticker price that you charge for your services. If there is no cost to changing the sticker price, then the currency doesn’t matter nearly as much. Think about the commodities’ markets, where prices change daily anyway, so if the dollar falls, the sticker price for oil increases automatically, and that’s that. This was already discussed in the other thread.
Second and more important: we need some more inflation. We want prices to increase. The inflation rate is still well below Fed target levels, and the CPI actually went down late last year (although I don’t believe core inflation has ever been negative). And as it turns out, a weaker currency can be a pretty decent way of inflating prices. It allows the increased costs of trade to circle through the economy a little more slowly than some other, much riskier methods of creating inflation, like dropping dollar bills out of helicopters as Milton Friedman once (jokingly?) suggested. As long as there is domestic manufacturing (and the US is still an industrial powerhouse, even after having off-shored so much productive capacity to China), the ability to substitute to domestic goods will be a buffer for real wages against the increased price of imports.
If core inflation starts creeping up past Fed target levels while the unemployment rate is decreasing, then the Fed can act to jack up interest rates and increase the dollar’s value. But for right now, the weak dollar is actually what we want and need.
Yes, we’re talking about the transition. I’m not arguing about the value of floating exchange rates. The point is that the U.S. currently imports more than it exports, and maintains a current account deficit. Under those circumstances, it seems to me that the decline of the dollar could do a lot of economic damage until a new equilibrium is eventually achieved.
The ‘good’ news is that the current account deficit is diminishing, primarily due to American consumers not consuming as much.
Frankly, I don’t care if the U.S. is a net importer of goods or a net exporter. But at some point, you have to have a reasonable balance of trade - you can’t maintain a current account deficit indefinitely without it hurting you. The problem in the U.S. is that it has lost competitiveness in the export markets for goods. If it is forced to increase the amount of the economy dependent on exports, and reduce the number of imports, it’s not clear to me that this can happen without a reduction in the standard of living for U.S. workers, because they may have to take pay cuts to remain competitive. In the meantime, the lower dollar is going to make the cheap imports that primarily benefit the middle and lower classes more expensive.
The wage cuts won’t come in U.S. dollars - businesses aren’t just going to tell their employees that their wages are being cut 30% to keep them competitive. Rather, the devaluing of the U.S. dollar against other currencies will mean that the wages of workers naturally come down in terms of purchasing power parity. That’s actually one reason why floating exchange rates are a good thing - they act as an automatic rebalancer when the levels of productivity change between nations, so trade can keep moving.
The ultimate result of all this is that the U.S. will probably wind up exporting more and importing less, while seeing the average citizen’s purchasing power and standard of living diminish to some degree.
It seems to me that the decline of the dollar should also have a negative impact on the ‘multiplier’ from the stimulus.
Yes, right now the risk is still deflation or at least lower-than-optimum inflation. The problem, as it seems to me, is that the large amount of quantitative easing and debt monetization means that inflation could rise up very rapidly once the economy starts to pick up steam. Once all that dead money starts to move, the fed may have to act quickly and strongly.
All of Bernanke’s tools for checking inflation and unwinding the money supply ultimately result in higher short-term interest rates.
But people buy imports for a reason - they have decided they are either cheaper or higher quality. Forces that cause people to substitute domestic alternatives therefore implies a reduction in standard of living or purchasing power. Will increased foreign demand for American exports improve that? Not really. It might help create jobs, but the only reason demand will increase is because the lower dollar means American goods are cheaper - but that also means American firms are making less money from them in terms of global value. That’s sustainable because they’re also paying employees with less valuable American dollars, but ultimately it will result in a reduction in the standard of living.
I’m not saying this is necessarily bad or unavoidable. It seems to me that America has been living beyond its means for some time, and now the time is coming to pay the bill. The natural standard of living should therefore be somewhat lower than what it has been recently.
The problem I see is that there is a risk of a trap here similar to a liquidity trap in reverse. The government has borrowed so much money that it is now dependent on unrealistic growth rates to keep up the payments while maintaining all its other entitlement responsibilities. If Bernanke raises interest rates, that will hurt GDP growth and also raise debt servicing costs, a double-whammy on the government. If the government responds by simply borrowing more money, as it’s likely to do, then nothing is really accomplished - especially if the government has to monetize its own debt. It’s just feeding money right back in the back door.
If the government doesn’t increase borrowing in response, then it will have to cut spending, and that increasingly means cutting entitlements to citizens. There will be a huge outcry against that, and this will probably put political pressure on the fed the likes of which it has never seen before. In addition, the government has already taken steps to start exerting more political control over the fed.
Given the complete lack of discipline and fiscal sense both U.S. political parties have shown, I have no faith that the current crew of idiots and fronts for special interests will be able to engineer a soft landing out of this mess.
In a normal economy a depreciation leads to lower consumption but that doesn't imply a lower standard of living. Essentially the economy is trading off lower consumption today for higher consumption tomorrow because of a smaller external debt. However in a demand-constrained economy, there is a free lunch because the depreciation boosts demand and creates jobs which also boosts income and consumption.
Also depreciation increases the size of the fiscal multiplier because it makes imports less attractive. Traditional macro analysis says that expansionary fiscal policy is less effective with flexible exchange rates because higher interest rates cause the currency to appreciate (for example this happened in the 80’s). Currently the expansionary monetary policy is overwhelming that effect and the currency is depreciating to the benefit of the economy.
As for the medium term outlook, if the Fed doesn’t raise interest rates significantly 2-3 years from now yes there will be inflation. I don’t think that is likely and there is a very strong political incentive, both domestic and international, to avoid that. If despite that, inflation rises that will be a mistake made in the future and not some kind of inevitable outcome of current policies which are broadly correct.
I said de facto. A declining dollar would directly generate no tax revenue, but otherwise it would have the same effect as a protective tariff, i.e., making imported goods more expensive than comparable domestic manufactures.
That’s not true. A tariff is very different from depreciation. A general tariff is equivalent to an export tax and will reduce both imports and exports as well as creating distortions in the economy.
No the impact of tariffs on domestic industry is not identical to depreciation, as Lantern indicates it creates administrative distortions, as well as acts as an export tax as well. In addition, tariffs tend to prop up declining firms and industries, fossilising bad management, etc. Depreciation is far healthier (when orderly) than “protective” tariffs.
Re Free Trade
Nothing “always” does anything, but Free Trade over the long run, like equity investments, is the clear lead winner, whatever the Left thinks.