Tuesday, February 6, 2018

Depreciating the Dollar

Secretary Mnuchin was asked if he ever spanked his child. He said he had heard that a spanking might be an effective parental tool at times for some children. The next day, he was arrested for advocating spanking to world leaders.

No not really. He did not say that. But Mnuchin did say he had heard that a depreciated currency might lead to more exports from that country. Immediately he was piled on by everyone from Tiny Tim to Tom Brady. Despite Mnuchin repeating a mantra found in almost every book on international trade, the world decided that Mnuchin had cleverly advocated a US policy to reduce the value of the dollar. Shout it from the housetops -- the new US policy is to depreciate the dollar so exports will rise and Americans will be protected from the world's vandals. No, not really. Could the press get any lamer?

But this is not about beating up the press. It is about ideas and facts. The first fact is that the dollar, despite limping a bit lately, is pretty darn strong. Second, most of us haven't a clue what it means to have a policy to depreciate the dollar. So let's work on that today. First, do 10 burpees.

The lovely chart below I graciously got from our good friend FRED at the St. Louis Fed. https://fred.stlouisfed.org/ It shows the exchange value of the euro versus the dollar. The euro is just one of many currencies I could have used, but this one is fine for our purposes. The chart shows that before 2000, one euro was able to command about 1.15 dollars. By 2008, the euro greatly appreciated (the dollar depreciated) to where one measly little euro could buy almost 1.6 dollars. At that time, the dollar was really weak. At the close of the business day on Friday, January 26, 2018, the quote was 1.24 dollars to a euro. Since 2008, the euro is much weaker and the dollar is much stronger.
  • Since way back before 2000, the dollar weakened considerably through about 2008.
  • Since 2008 the dollar is much stronger
  • Since 2009, 2010, and so on the dollar is stronger
  • There is a weakening of the dollar since sometime in 2017.
As far as the euro data show, the dollar is pretty strong. Things have turned of late but clearly not enough to change the general impression of a strong dollar.

So my first point is that there is no evidence of any real weakening of the dollar. But what if this short-term turn means the dollar is going to continue to fall. So what? And would our government want that outcome enough to actually promote it?

Even small birds know that a depreciated currency is good for exports, right? Sorry Charlie, but not really. Often a depreciated currency simply means a country's goods have become less competitive in global markets. If foreigners prefer France's goods over US goods, they don't need as many dollars and thus the value of dollar falls. Thus the depreciated dollar may simply be the sign that a country's goods have lost favor in the world. A falling dollar does nothing to heal the thing that produced the decline in competitiveness.

But that is not the whole story. Not by a long shot. A depreciated dollar means that US households who want to import Cognac from France or sausages from Germany will find all that stuff costs more. If they really prefer these imported goods over US goods and continue buying them, then they have to pay more. Ouch. I am not sure our US government wants to be responsible for that ouch.

And that's not even the whole story. We love it when foreigners invest in the USA. If they buy stocks, they drive the stock market up and we get richer. If they buy bonds, they drive interest rates lower and we can borrower cheaper. If they invest in new businesses, employment and wage opportunities improve. In short, we love it when foreigners invest in the USA. If foreigners believe the dollar will fall, then this weakens any returns they would expect to gain in the USA. That's because to bring their earnings home to their countries, they will have to use a depreciated currency. Would Mr. Mnuchin really want to be responsible for telling those foreigners not to invest in the USA?

It is true that some countries -- especially developing countries that rely greatly on foreign exports for growth and development -- take measures to depreciate their currencies. It is unfair and it hurts the US when these countries do so but that does not mean that it makes sense for rich, industrial countries like the US to copy them. Often when these countries behave like that they are breaking international trade rules, and there are ways to address those issues without following bad policy with more bad policy.

Furthermore, playing exchange rate bingo with the rest of the world is not a winning strategy. We can hope to expand our exports by depreciating the dollar but then export-dependent countries will simply retaliate. They have much more to lose than we do. It is hard to see us winning that game and in the meantime we all suffer.

Mnuchin denied it was the policy of the USA to depreciate the dollar. Let's all hope he really means that.

No comments:

Post a Comment