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.

Strong Dollar. Who are We Going to Blame Now?

President-elect Trump rode into Washington on a horse named Unfair Competition. One part of the story is how other governments manage their currencies so as to gain a competitive advantage against the US. And while I agree that countries sometimes do that, such currency manipulations are not among the dominant forces now. If anything we in the US are the one’s causing our manufacturers to lose competitive advantage.

Why worry? Or was that What me Worry? Regardless, in the last month (between November 4 and December 2) the dollar went soaring. It rose in that short time by more than 10% against the Japanese yen and 8% relative to the Mexican peso. It rose by about 5% against the euro and the Brazilian real and by lesser amounts against the Korean won and the Chinese renminbi. It held steady against the Canadian dollar. When the dollar rises by such large amounts US exports are less competitive in global markets. So we fret. This puts US exporting companies at a disadvantage. Clearly the bad guys must have done this to us!

But alas, I don’t think that is true. Most experts are saying that we did it to ourselves. Experts are saying that the Trump bump is making people more optimistic about the US economy. This optimism makes US assets like bonds and stocks much more appealing to investors. It also emboldens Ms Yellen and her band of Federalies to raise interest rates. Thus we are receiving a tsunami of attention from global investors who must first buy dollars so they can buy our very attractive assets. This revived love of dollars means a higher value for the dollar.

This is not a trick played on us by evil China or Mexico. The negative impacts on US exporters are because investors have concluded that Trump will be good for the US economy – at least for a while. Even before this latest wave of foreign investment, the world marveled at how the US recovered after the global recession while other countries continued to struggle. This has been lifting the dollar for some time and has made life difficult for US exporting companies. During the last two years the dollar rose by 13% against the renminbi. It also rose by 8% against the yen and by almost 30% against the euro. 

This doesn’t look like unfair currency manipulation to me. It has more to do with US policy and economic performance. It is market forces working in a global economy.

So maybe we should dispense with the unfair competition talk and ask ourselves what we really want. If the "experts" are correct, then it appears that the best way to help US exporters is to do something to make the US weaker and grow more slowly. But that is tantamount to throwing the baby out with the bath water.

Instead, if we really want to help our exporters, we ought to have policies that do not weaken our trading partners. When they get stronger they will buy more – and some of that extra spending will be directed toward US goods and services. Slapping tariffs on goods we import from key trading partners will do nothing but weaken them, make the dollar stronger, and smack our exporters. Are you sure that’s what we want to do?

One last point. The last time I looked it took two to tango. It also takes at least two to do JD shots but that’s a different story. Trade is more than an export story. While the optics are vivid with respect to exporters and their workers – countries gain with strong imports and with strong inbound and outbound investment. Keep in mind that when the dollar appreciates and negatively impacts exports – that same rise in the value of the dollar improves the situation for importers and makes foreigners more interested in investing in the US. Keeping in mind that many US imports are business goods that add to US productivity, a high and rising dollar is sometimes on net, a great boon to American business. The optics of the latter are less clear than the export story but nevertheless are important.

Summary: We should be alert to real rather than imagined unfair competition. Let's stop tilting at windmills. Competitive advantage of a country is determined by more than export sales. Policy should focus on the many avenues in which trade enhances American well-being. 

Lesson 10 The Value of the Dollar is the Steve Martin of EconoWorld

Steve Martin is a wild and crazy guy. So is the value of the dollar. There is much being said about the value of the dollar of late. So I thought I would look at it a little more.  My conclusion is that it is wild and crazy. That means that undo concern about recent highs in the value of the dollar could be misplaced. Here today gone tomorrow might be apt.  Let’s see what you think.

But first, let’s admit that the value of the dollar is an elusive concept. You have a dollar in your hot little hand. What is its value? In buying a JD, one measly dollar is worth a drip or two. Or a dollar might get you a really large handful of red jelly beans. Point – the value of the dollar depends on what you are buying. When it comes to domestic spending we have something called the Consumer Price Index. We use it to judge how much a dollar will buy in terms of all the goods and services consumers usually buy. No Charlie – it does not include pole dancing.

When the prices of things you usually buy rise quickly you lament that the value of your dollar is going down. When prices fall, you are happy that your dollar stretched further.

The above is all correct but it mostly pertains to spending on domestic goods and services in the US. There is an international aspect of the value of the dollar because in order to buy things abroad, you first have to buy foreign currency. So we talk about the value of the dollar as it relates to buying euros, yens, or loonies. If today I can get more euros or yens or loonies with my pretty green dollar – then today I say that the dollar strengthened – the value increased.

Since we trade with many nations, we are concerned with how the dollar’s value is changing with respect to an average of the currencies of our main trading partners. Those main trading partners include Mexico, Canada, China, the UK, the Bermuda Triangle and more. The Trade Weighted U.S. dollar measures how the dollar is faring against the currency values of our main trading partners.

So let’s call the value of the dollar – TWMTP. If you want to say it out loud – say TwaMooTooPoo. But have at least one JD before you try to say that. Below is what I learned about the value of dollar by looking at the data from 1973 to 2014. In 1973 I was starting my PhD program at UNC and my son Jason was born. But that is a whole other story.

In January of 1973 TWMTP had a value of 108. As of July 2015 it was 92. A lot of JD has gone under the bridge during those 42 years. I will say more about some of those years – but my first point is that at 92 – the dollar fell by about 15%  relative to 1973. So if someone tells you that the dollar is very strong right now you can look her in the eye and say – compared to when Jason was born, the dollar weakened by 15%. No offense meant to Jason. 

There must be more to the story. In April of 2011, TWMTP was 68. That was pretty low. In the past four years the dollar recovered to 92. So you could say --  okay smarty pants the dollar appreciated by 35% in the past four years so the dollar is strengthening. The dollar is clearly high and strengthening during the past four years. This is behavior that has some people bothered. A 35% appreciation seems bad to them – but where is it going to go from here?

Future exchange rates are not easy to predict.  The annual mean change of TWMTP over the last 42 years was -0.4%. If you use the past mean as a predictor of the future, then it says you predict no change next year – or zero percent. In those years since 1973, the dollar increased in 19 years and it decreased 22 times. The annual standard deviation was approximately 6%. That’s pretty wild and crazy. And the range of those annual changes was impressive. TWMTP rose by a high of 10.5% in 1982. It fell the most in 1986 when it depreciated by 18%. Now that is a roller coaster. So if our worry and consternation is about a high and rising value of the dollar in the future – our recent bout of appreciating dollars may or may not have much staying power.

But that isn’t the whole story. Within that 42 year span, there have been some long waves of exchange rate change.  Check out these waves (please don't get sea-sick):

            Jan 1973 to June 1980       -14%

            June 1980 to Feb 1985      +56%

            Feb 1985 to March 1995   -44%

            March 1995 to Jan 2002   +36%

            Jan 2002 to April 2011     -62%

            April 2011 to July 2015    +35%

These long waves of change lasted as long as a decade! Of course during any of these longer time periods the value of the dollar wriggled up and down often.

This background helps us phrase the question about the future. Yes the dollar has increased in value during the last four years. Does that mean we are on a long wave of dollar appreciation? The dollar is 35% higher than in 2011. But notice at 92 it is still well below the 110 that prevailed in January of 2002 and the 108 that existed in 1973. In fact the current reading of 92 is lower than approximately half of the years between 1973 and 2015.

Since the statistics give us little to bet on in the way of future changes in the value of the dollar – that leaves us with theory.  So long as our trading partners struggle and we look like an attractive investment location – it's hard to imagine the dollar falling in value very much. But how long can that continue? Is US policy that good and foreign policy so terrible that global investments will keep flowing to dollars and US investments? It seems not so long ago that the reverse was happening. We were worried that the yuan and the euro would steal the dollar's thunder.