Before the Iraq war, the US dollar and the Euro were essentially on equal footing, with a roughly 1/1 exchange rate. Now it takes $1.24 to buy one Euro, and I understand experts are predicting that will rise to $1.30 by year end.
The debate: Is a sinking dollar a troubling sign for the future of the US economy? Or is it a blessing to be welcomed?
I know that some argue that a weakened dollar is a good thing since it means US-produced goods will be cheaper on world markets. Thus a weak dollar means more exports and more manufacturing jobs in the US. This argument has always seemed a bit suspect to me. Taken the argument to its logical conclusion, the US would be better off as an impoverished third-world country, since that would mean our goods would be cheap on the world market.
But I welcome input from those better-versed in economic theory than I. Do any dopers have thoughts on the sinking dollar and what it portends for the US economy?
I do not think it is a good thing. According to theory, Europeans should start to import more American products as they become cheaper. This would cause the dollar rate to rise as they use their dollars to buy our stuff. But that never quite seems to happen. I can’t remember where I read this, but the basic idea was that Europeans tend not to be price shoppers to the same extent as Americans; rather they prefer to maintain and nurture existing business relationships. So they are less likely to jump at the advantage of a lower price, at the expense of sacrificing an existing business relationship.
And not only that: We’re already far too isolated, and having things in Europe so expensive makes it even harder for us to travel there.
I sort of chalked it up to the large scale deficit spending recently. For good or bad (and there can be good reasons for a government to run a deficit) that sort of thing tends to expand the money supply in dollars and lead to a weakening.
Hell, it’s be weaker if the Japanese stopped hoarding dollars. Then we’d be working towards equilibrium.
I thought the U.S. was a net importer of goods. Doesn’t that kind of scuttle the “U.S. goods would be cheaper” argument? Or is the idea that a low U.S. dollar would help correct such a trade imbalance?
This sure isn’t going to help gas prices, at any rate.
Most changes in an economy has two effects, a negative one and a positive one. A sinking dollar makes US produced goods cheaper on world markets and helps manufacturing. It also makes international investors less likely to invest in the US (FDIs are way down) and that hurts the US economy, especially longterm.
America is also a net importer of goods. A sinking dollar means that imported goods become more expensive for American consumers, which will lead to higher inflation. A rising inflation also hurts investments. But US produced goods will be better suited to compete with imported goods on home markets, which again helps manufacturing.
Worldwide, a lower dollar should helps the economy because oil is traded in dollars. Gas would become cheaper everywhere, except in the US. Oil producing countries (particularly Middle East + Russia + Norway) will see a drop in their income and that may send these countries into a depression. When I say should I mean will but so far the effects of a lower dollar has been more than offset by rising oil prices.
IMO, it’s not good thing at all when a currency is declining significantly. It means that the economy of the currency is severely unbalanced and that the market tries to correct for that.
Longtime readers of the financial press will recall that when a currency declines, it’s a bad thing. Imports become more expensive and that’s inflationary. For example, companies that use imported inputs have to raise their prices. Consumers become perturbed. Insert interview here.
Longtime readers of the financial press know equally well that when a currency appreciates, it’s a bad thing. Exporters find that their products no longer compete as well abroad. The country experiences a, “hollowing out” of industry or de-industrialization depending upon what the catch phrase of the day is. Insert troubling interview here.
Currency changes, in the eyes of a journalist are always bad, never beneficial, for any country at any time. Of course, fixed exchange rate regimes will also lead to hand-wringing. It’s best if currencies never decline, fall or stay the same.
Personally, I am unconcerned about the dollar’s present level. OTOH, an actual collapse of the dollar really would be harmful. In order to avert its downward spiral, a sharp increase in interest rates would be necessary, which would necessitate a recession. Furthermore, if such a financial crisis occurred, the dollar would lose its attractiveness as an international store of value: the benefits from seigniorage would then no longer accrue to the US.
…the Chinese were to start selling their US Treasury Bonds? The whole huge deficit (in US trade with China) has been covered by the Chinese buying treasury bills. Since the Chinese buy virtually NOTHING from the US, they recycle their trade surplus with us (from selling us dirt-cheap copies of tools, appliances, clothing, etc.) by purchasing these bonds.
If they started dumping these bonds, US interest rates would soar, and the world would enter a depression. Of course, the Chinese wouldlose big time, but you never know what they will do.
I see the whole US-China trade as extremely unhealthy for the US-we lose all of our factory jobs, and China gets a time bomb in exchange.
That’s because you are missing key portions of the argument. To make things simple, I’ll use Canada v. the US (I have currency in both countries and follow it pretty closely).
Let’s say one wishes to make some small but pretty gimcrack for sale in North America. The company producing this trinket decides to manufacture in it North America (to take advantage of NAFTA and be able to sell it in Canada, the US, or Mexico). The market for it is in the hundreds of millions; we’ll ignore the demand side for the moment.
The owner of the Company, Gimcracks unlimited, does research in July of 2003 and finds that the two best places to manufacture are Manitoba and Ohio. He finds two small towns, each with a workforce of 1,000 people he could employ. He further finds that, due to the American work ethic, business regulation, and investment in automation, that Americans are more productive than Canadians. Each Canadian will product 100 gimcracks an hour; each American will produce 125 per hour*. Further, wages, measured in local currencies, are the same. For the purposes of this discussion, we’ll call it $20 an hour, a decent wage for factory work. So, our Manitobian will get $20 loonies per hour, our Ohioian will get 20 greenbacks an hour.
Our factory owner, who we’ll call Fred, sits down and works this out. The Loonie was worth about 70 cents on the dollar in July of 2003, so if he employs someone in Manitoba, even though Fred is handing them a 20 dollar bill every hour, his actual cost, in US funds, is actually only $14. That means a Manitoba-produced gimcrack costs him $0.14 US ($14US per hour/100 gimcracks per hour). On the other hand, the US-produced gimcrack costs him $0.16US to produce ($20US/125). He decides to employ 1,000 people in Manitoba, and the factory in Ohio is shuttered.
Fast forward to today. The Loonie is worth 81 cents US. Fred’s labor costs have gone up to $16.2 per hour US or $0.162US per gimcrack. Fred closes the plant in Manitoba, putting 1,000 Canadians out of work, and opens a plant in Ohio, employing 800 people (and producing the same number of gimcracks).
Was that good for the economy? Well, it depends, now doesn’t it? Those in FactoryTown, OH think it was a damn good thing, seeing as how they have jobs. Unfortunately, the cost of softwoods (imported from Canada) has gone up from a buck a board foot to $1.33US a board foot (since the Loonie has risen by 33%). The cost of, say, MS Word (created by a US company) has remained the same. They have jobs, which they didn’t before. The cost of gimcracks has risen for all of the purchasers in the US, by about 15%. It has fallen by about the same amount for purchasers in Canada.
The folks in Manitoba feel the opposite way. They are out of jobs, but if they can find jobs in another field (which, from what I have read about Manitoba, is unlikely), they are will find that the $20 an hour they are getting goes farther. They find that US good are cheaper than they were, while Canadian goods cost about the same amount.
Right now, there is considerable anguish about the lack of job creation in the US. A weaker greenback means that it becomes cheaper to move manufacturing back from overseas, at the cost of a higher cost for imported goods. This means that we shouldn’t plummet the dollar to next to nothing, but rather we ought to lower it to the point where we aren’t complaining about jobs and the lack thereof.
There are other, more attractive things we can do to bring jobs back - if an American worker created 150 gimcracks an hour, cost per would be .133 per gimcrack, making it more attractive to create the gimcracks locally. I am largely ignoring these sorts of increases in productivity because the debate is on the value of the currency.
To choose another, more pressing example. A blooded, experienced, capable software developer in India makes about $20 an hour US right now, in equivalent rupees. There are costs associated with outsourcing ones development department to India above and beyond the cost of the programmer. Let’s assume that those costs are about $10 an hour (this covers paying the PM extra money to make calls late at night, time lags, communication difficulties, etc). This means when a software company looks at developers, an $80,000 a year software developer is competing against a $60,000 a year Indian software developer. Now, assume the greenback falls against the rupee. The Indian developers salary stays the same in rupees, but now it costs $30 an hour to purchase those rupees with which to pay the developer. Suddenly, the US developer is competitive with the Indian one, and offshoring reverses.
To use a more personal example: I am a US programmer, living in Canada, contracting to American companies. If a US company pays me $20** an hour US, I was making good money when I moved here a year ago (about $30 an hour in the local currency). I have spent the last year effectively taking a pay cut; that $20 an hour now only buys me $25 in the local currency. If the Loonie continues to climb, eventually I’ll have to contract to Canadian companies, or make less than $20 an hour. A falling dollar is bad for me, personally. On the other hand, many of the goods I buy (books, mostly) are becoming less expensive, because they are denominated in US currency.
The best thing for the US, and for the world, isn’t for a currency to grow weaker, but for a currency to accurately reflect the value of the underlying goods and services. If a US worker is 25% more productive than a Canadian (or Chinese or Indian or Japanese) worker, the currency should reflect that.
That is not what’s currently happening. A few of the major economies, particularly India, China, and Japan, are propping up the greenback by purchasing large amounts of them. This gives the workers of those countries an edge (it keeps the factory in Manitoba, as it were). On the upside, this keeps the workers of those countries employed; on the downside, it also keeps them relatively impoverished, because anything they wish to purchase that is not produced locally (anything made in the US, for example) is more expensive than it would otherwise be.
Valuing a currency isn’t an either/or thing. It is not necessarily true that, if a Loonie worth 80 cents US is a good thing, then one worth 90 cents is better (because an increasing number of Canadians will find themselves out of work, as US workers become more competitive); the statement that “the US would be better off as an impoverished third-world country, since that would mean our goods would be cheap on the world market” isn’t the correct conclusion (although it is a logical one) because the goal is to have a good balance between employing ones workers and having the value of their labour accurately reflected in the value of the currency.
Right now, the greenback is too strong. It values the time and labor of Americans too much; it suggests that Americans are more productive than they really are. As a result, they are uncompetitive on the world market. The result is that companies move jobs elsewhere.
Ultimately, de-valuing the dollar is a sort of tax on those who have dollars to give some to those who don’t. If I have a job, then making the greenback of less value means that I take a pay cut, since my greenbacks will now purchase less stuff made in foreign countries. The upside of that is that American workers now become more competitive, so if I didn’t have a job before, I can now find one. Currently, the imbalance of trade suggests that the dollar is too strong, and needs to fall. A lot.
There are a lot of other factors that affect the value of a currency, and I’ve glossed over them completely. IANAEconomist, caveat lector, emptor and cave canenum.
the 25% difference is what the Bank Of Canada considers the competitive difference between the US and Canada. This comes up in the business section of the Toronto Star about once a month.
Ralph, I think, puts his finger on a larger problem, IMHO.
At the same time, I should note that the Chinese aren’t the only huge foreign holders of T-Bonds: Japan, Taiwan, Singapore and various Asian tigers have purchased a lot over the past couple of years to prop up the dollar.
This points to an underlying problem: the US saves too little. That is, the US puny savings rate is overwhelmed by the sum of
the amount that the US invests
and
the amount the federal government borrows to cover the Republican’s budget deficit.
The difference (S-I-D) has to be made up by foreign purchases of US assets (stocks, bonds, whatever). (D=federal deficit).
If foreigners decide that this is a Ponzi game and slow down their purchases of US assets substantially, then investment will have to decline by a similar amount. A sharp fall in US investment would presumably trigger a recession.
What bashere said was an excellent explanation.
The entire world situation we have today has its historical roots as follows, in brief:
World on gold standard until 1914, when WWI breaks out and everyone except the US goes off it.
Postwar attempts to get back on a gold standard are botched, and partially contribute to the Great Depression, during which time most countries once again go off the gold standard, except the US, which depreciates the dollar to 35 per ounce from 20 per ounce, but also prohibits ownership of bullion. So while there is official gold backing, for all practical purposes it’s a legal fiction.
Post WWII, agreement is reached on what is called the “Bretton Woods” agreement, in which dollars can be exchanged for gold at 35/ounce, and vice versa, on demand by non-US entities and persons. To address the inevitable occasional currency and debt crises, the IMF is founded.
Persistent deficit spending that spirals out of control as a result of Vietnam leads the US to abrogate the Bretton Woods agreement in 1971.
The informal system worked out since the death of Bretton Woods amounts to a dollar standard, in which the dollar is accepted as the world’s reserve currency.
The Mexican, Asian and Russian currency crises of the late nineties leads these countries to value large central bank reserves to defend their currencies, which partially explains the persistent buying of dollar assets that is currently propping up the dollar. In the case of China, the purchases are meant to maintain the yuan’s official rate to the dollar. In the case of Japan, it’s part and parcel of their omnipresent protectionism, which extends to everything and is a branch of their de facto one-party political system.
Our troubles with the current account deficit really began in the late nineties, when this persistent buying distorted the value of the dollar to a degree not known before. Even though the dollar has since come down, obviously it hasn’t been enough.
Gradually, the Asian nations are beginning to question the efficacy of holding large dollar reserves; see for instance this story from China Daily questioning the efficacy of these reserves and politely proposing that reserves be diversified to other currencies besides the dollar (which, I see on preview, goes to Measure for Measure’s and ralph124c’s point). As well, India has recently proposed using a portion of its reserves to finance badly needed improvements to their public infrastructure.
Me, I see all of this as somewhat similar to the early sixties, when the first cracks began to show up in the Bretton Woods system because of an excess of dollars at that time. From Money of the Mind, by James Grant, describing what the Fed did at that time to stop a developing currency debacle:
Note that while the Fed has recently been raising short-term rates, long-term rates have steadily declined: the 10 year bond has fallen in yield from 4.8% at the beginning of June to right around 4% today. So just like in Operation Twist, foreigners holding US bonds have been compensated for the recent dollar decline by a rise in the value of their bonds, which rise as yields decline. One hesitates to say that the Fed has done this deliberately, but it should be noted that Greenspan is a gold bug, and knows his financial history.
In any event, sooner or later our economy will truly revive, reinvigorating FDI flows as well as speculative investment flows into the stock market, and the dollar will look OK.
Next after that, if the “excess of dollars” remains unaddressed, will come something similar to the 1971 event, which I figure will be a rejiggering of world reserves out of the dollar and into other currencies, effectively ending the dollar standard. But we’ll have bought some time in the meantime to perhaps prevent such a thing from happening. That will depend on a) getting Kerry into the White House and then b) hoping he doesn’t merely play Nixon (who was the one who actually abrogated the Bretton Woods agreement) to Bush’s LBJ. We shall see.
Here are some facts about Asian foreign reserves held by Central Banks, from a 9/18/2003 article in The Economist:
Not to mention Indonesia, et al. Basically, asians are buying US bonds and exchanging them for manufactured products. With luck, this imbalance will wind down, rather than crash.
Readers of the financial press also know that hand wringing about the US trade balance has been going on since at least the Reagan days.
Actually, I thought I showed it’s been going on since 1960, but whatever.
Seriously, though, I’ve thought for a while that the big trade, the one to get right, is when the dollar imbalance finally hits. I’ve actually been feeling more nervous than usual lately, because this latest plunge in the dollar has been said to be directly caused by numbers that showed a weakening trend in inflows into the dollar.
Realtime update (for the heck of it): the dollar index opened tonight down another half point to 85.40, gold is up 4 to 428, the Nikkei’s down 245. Tomorrow could wind up being one of those wonderful, classic October days. Personally, I think we should blame it on the Red Sox beating the Yankees.
Personally, I’m not too worried about an imminent US$ crisis.
Prediction: Neither the Australian or Canadian dollar will reach purchasing power parity vs. the US dollar this year. Nor will they be over 10% “over-valued” against the US dollar next year.
That’s all fine & dandy, but the trend, for 40 plus years by now, has been towards a deterioration in the position of the dollar relative to other currencies. I was thinking about this on the way home from work today, and really, the end of the dollar as a reserve currency is more or less inevitable in the next twenty years. Whether that will wind up being a good thing or not is, of course, impossible to say. In some ways it will be good, but I have no faith that the governments of the world will finally settle on a uniform standard for valuing currencies, because the current mess, in which every government gets to choose the way it prefers, suits all of them just fine.
Which means the imbalances will continue, just in some other form. And most of the world will continue to be the poorer for it.
What really puzzles me: in the days of Bretton Woods (when we had a fixed mark/dollar exchange rate),we imported a TON of stuff from germany. The dollar was pegged artificially high against the german mark (I think it was 5 marks=1 dollar). This meant that German goods were dirt cheap-you could buy a VW bug for about $500. I can also remember german made toys, clothes and shoes. Now that we have more realistic floating rates, you don’t see anythiing here (from germany) except luxury goods…a german-built car is very expensive.
Yet, with China, we have a huge deficit, but the Chinese keep the exchange value of the yuan low! An imported here repported that he can buy a chinese-made, 3-piece luggage set for $7.00! Chinese-made sneakers/athletic shoes have a landed cost around $2.75/pair! There is NO way that any USA mfg. can compete with these prices…so I would argue that our continued trade with China will result in virtually all manufacturing jobs leaving this country (unless the exchange rates change)!
FWIW, most studies suggest that technological advance displaces far more workers than foreign trade does.
Manufacturing employment as a share of total US employment has been dropping for years:
1970: 26.3%
1980: 22.1%
1990: 18.0%
2000: 14.7%
Ironically, the rise of the Chinese during the 1990s mattered less, since a lot of the US’s so-called “Hollowing out” had already occurred.
I’ll also note that Chinese productivity is lower that that of the US. As its productivity increases, so will wages. Skeptical readers can look to the example of South Korea.
Oh, and yes, I agree that the US apparel industry is highly vulnerable, as are other forms of light manufacturing.
As long as the US combines high federal budget deficits with a low private savings rate, we are going to have a trade deficit.
This trade deficit will disproportionately affect the manufacturing sector.
Every time a dollar is traded on the foreign exchange market, there must be both a buyer and a seller. Put another way, if our low net National Savings means that we are selling lots of bonds to foreigners, we will have to buy something in return. That “something” will be foreign goods or commodities, whether they originate in Japan, Saudi Arabia or China.
It’s ironic (but unsurprising) how little attention is paid to these wholly mathematical linkages in the US media.