Christina Romer is a person I’m happy exists. She has the ability to explain complex ideas in ways that make sense on an everyday level. She recently wrote in the New York Times on our countries fascination with maintaining a “strong” dollar. At some point I’d like to dig more into a point Ms. Romer touches on, the tying of the Chinese renminbi to the dollar, but for the moment I’d like to focus on the fallacy that a “strong” dollar is always a good dollar.
The dollar, through its exchange rate, is a price. Market forces determine how much the dollar is worth and the government has relatively limited control over this process. Ms. Romer does a great job of explaining this process
The supply of dollars to the foreign exchange market comes from Americans who want to buy goods, services or assets from abroad. The demand for dollars comes from foreigners who want to buy from the United States.
Anything that increases the demand for dollars or reduces the supply drives up the dollar’s price. Anything that lowers the demand for dollars or raises the supply causes the dollar to weaken.
Consider two examples. Suppose American entrepreneurs create many products that foreigners want to buy, and start many companies they want to invest in. That will increase the demand for dollars and so cause the dollar’s price to rise. Such innovation will also make Americans want to buy more goods and assets in the United States — and fewer abroad. The supply of dollars to the foreign exchange market will fall, further strengthening the dollar. This example describes very well the conditions of the late 1990s — when the dollar was indeed strong.
Now suppose the United States runs a large budget deficit that causes domestic interest rates to rise. Higher American interest rates make both foreigners and Americans want to buy more American bonds and fewer foreign bonds. Thus the demand for dollars increases and the supply decreases. The price of the dollar will again rise.
This example describes conditions in the early 1980s, when President Ronald Reagan’s tax cuts and military buildup led to large deficits.
So what should this mean for our policy? Essentially trying to manipulate the dollar’s price is fool’s gold. It would be far more fruitful to a) understand what the price of the dollar is telling us about our economy and the impression others have of our economy and b) remove the win-lose connotation behind our descriptions of a “strong” and “weak” dollar
This second point seems simple but runs quite contrary to human nature. To essentially rebrand the dollar it would take a concerted effort to move away from the status quo. This effort is one that I think is completely worth it. Avoiding the hysteria that comes when we the see Euro valued at $1.41 is a worthwhile goal and would allow us to have a far more coherent monetary policy message towards the public (privately it seems pretty clear we already have these common sense policies in place). So to do our small part to help achieve this goal this blog promises to try and use the terms “expensive” and “inexpensive” when referring to the dollar in the future.
-Bo
-Bo
This is the sort of thing Dani Rodrick discusses in his book "The Globalization Paradox." One of his main points is that a lot of economists have a pretty good understanding of how our country's economic policy ought to go but have determined it's too complicated for the everyday economic-layman to understand. The convention has thus been to make broad sweeping cover-all statements that even the simplest of folk can understand i.e. a strong dollar is a good dollar. Unfortunately, some of our less intelligent politicians maintain the practice of then taking these generalized statements and turning them into gospel. Put in the oven, wait a couple decades, and enjoy a massive deficit.
ReplyDeleteI think that's a really fair point. What ends up being especially frustrating for me is that people start to personally identify with these memes. We have team pro-trade and team pro-american work force. Or in this case team strong dollar, team no one willing to say the strong dollar is not always a good thing. I think it is human nature to emotionally attach ourselves to ideas, I also think for stuff like this it can create a lot of problems.
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