March 05, 2015
Regular readers of BTP know that the over-valuation of the dollar is one of my pet themes. There are two big issues with the over-valuation.
The first is macro economic. An over-valued dollar makes U.S. goods and services less competitive internationally. If the dollar is over-valued by 20 percent against other currencies then it has the same impact as if we were to impose a 20 percent tariff on all our exports and give a 20 percent subsidy on imported goods. Needless to say, this leads to a much larger trade deficit than would be the case if the currency were not over-valued.
The trade deficit creates a gap in demand. The deficit is currently around 3.0 percent of GDP or $540 billion a year. This is money creating demand in other countries, not in the United States. There is no easy way to make up this shortfall in demand. Investment and consumption will not conveniently rise to fill the gap. We could in principle fill the gap with larger budget deficits, but given religious views about balanced budgets among people in power, that is not going to happen.
This means that an over-valued dollar is likely to lead to major shortfalls in demand and unemployment. Or, to use the term currently popular among econ policy wonks, it leads to “secular stagnation.”
The other issue is distributional. An over-valued dollar hurts the workers who are subject to international competition to the benefit of workers who are largely protected from international competition. Textile workers and autoworkers take it on the chin, while doctors and lawyers, who ensure that trade agreements don’t subject them to international competition end up benefiting. They get lower cost imports, without experiencing any downward pressure on their wages. (Businesses like Walmart and GE, who import much of what they sell in the U.S., are also big beneficiaries.)
The WaPo chimed in with those beneficiaries in a Wonkblog piece telling readers which countries are best to visit to take advantage of the over-valued dollar. Needless to say, there will probably not be many manufacturing workers who will take advantage of the information in this piece. However, there will be many doctors, lawyers, and congressional staffers (including those of progressive representatives) who will find this useful information.
And you wonder why no one ever does anything to make the dollar more competitive.
Addendum:
I will give a quick response to the argument by Yanis Varoufakis raised in the comments. I think Varoufakis is mistaken. They are no secret conspiracies here, everything is pretty much right on the table. There are segments of the elites that stand to gain from an over-valued dollar. This includes businesses that are outsourcing to get cheap labor and retailers like Walmart who undercut competitors by setting up low cost supply chains in the developing world. Finance also tends to be happier with a dollar that goes farther overseas and less inflationary pressure at home.
The economy as a whole does not in any way need an over-valued dollar, nor does the U.S. uniquely “benefit” from some special privilege as the world’s reserve currency. On the first point, if the dollar had been lower in the years from 1997 (when we first began running large trade deficits) to 2008, we simply would have seen a smaller trade deficit and more employment. That may not have been true at the peak of the 1990s cycle, when the Fed may have tightened up enough to choke off any employment gains, but it would almost certainly have been true for much of the rest of the period. If there is a basis for some crisis in that story, it’s hard to see what it is.
On the second point, the euro is also used as a reserve currency, albeit to a much smaller extent than the dollar. Nonetheless, this is not a zero/one story. The euro and its predecessor currencies also rose in value against the currencies of the developing world following the East Asian financial crisis, although the timing was different. The euro peaked in the year before the financial crisis at close to 1.6 dollars. If we enjoyed some special privilege then the euro zone countries enjoyed a super special privilege.
In reality the over-valuation of the euro was contributing to the enormous imbalances that were the basis of its economic collapse. That’s not a privilege anyone should want to seek.
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