Strengthening U.S. Dollar: Bad for the U.S. Economy and the Global Imbalance

The US dollar jumped at the "strong" job market numbers last Friday. "Strong" was of course only relative to expectations, because the US still lost 247,000 jobs in July. But the-better-than-expected non-farm payroll figures provided the strongest signal yet for an imminent economic recovery in the US.

It is not clear if this is another round of strength for the US dollar or just a temporary surge. If the US dollar does continue to gain strength, however, not only is the US recovery endangered but also the gross global imbalance that has emerged since the eighties probably has to wait much longer to be redressed.

US household savings rates have been rising in recent months suggesting that the impending recovery is likely to be quite unlike earlier ones--this one should be marked by weak consumption. This clearly is exactly what the US needs: it has to live within its means. The years of large current account deficits just cannot continue forever.

For the US economic recovery to be real, therefore, the US needs to boost its exports and that means the US dollar should weaken. External demand has to gain while domestic demand ebbs.

A strong US dollar policy is just unrealistic for the US economy. With a weaker US dollar, employment will rise and aggregate consumption can and will rise, but the American savings rate needs to edge higher if it is to repay its foreign debt and deal with the gross external imbalance.

I am hoping for a moderately lower US dollar, but I do not think the US dollar would crash or need to depreciate a lot. But as I have maintained in earlier writings, the often cherished assumption that freely floating exchange rates will always serve the world best is just unrealistic.

Comments

[doubleguns:]

Since the Chinese will not free float their currency against the dollar the effect will be minimal unless the dollar drops a lot more. This will cause the Chinese to drop the peg to the dollar since keeping it would be very inflationary for them. Possibly they know this and that is why they are buying up so many commodities right now to 1) get rid of dollar holdings, 2) protect from coming inflation until they drop the peg.

The QE is going to give us a weaker dollar, question is who is following us down that road. Seems many are traveling this path. If everyone does it the weaker dollar will have no value to us and just be very inflationary.

"But as I have maintained in earlier writings, the often cherished assumption that freely floating exchange rates will always serve the world best is just unrealistic."

I disagree. I believe a free float with China would be very beneficial to the US economy and our balance of trade. We might even start producing products again in this country if the price of the Chinese products reflected prices based on a properly valued exchange rate. I am curious why you feel otherwise.

Aug 10 09:49 AM

[Living4Divi...:]

This is a well-written article, Professor Ho.

Last week everyone was saying that the dollar was falling to its doom. this week they are saying that the dollar is rallying to the sky. It is just part of the ebb and flow of currencies. That's why I am not a currency trader.

In your article you said:
"the often cherished assumption that freely floating exchange rates will always serve the world best is just unrealistic"

We don't live in a world where exchange rates are fully "freely floating" - many regimes are pegged or semi-pegged to the dollar such as the Yuan. Even when the currency is deemed to be freely floating - in practical terms the free float is never allowed to float freely - other currencies which "freely float" against the dollar (Euro, Yen, Sterling) are manipulated by the respective governments.

Aug 10 11:12 AM

[tadpole76:]

I respectfully disagree about needing a weaker US dollar to address trade imbalances and the current account deficit. Beggar thy neighbor currency & trade policies are a road to nowhere. China needs to "unhing" from their managed float to the US dollar. This will allow the US to become more competitive in exports. We also need to re-work NAFTA as this has further hindered our ability to export more. The US also needs to be fiscally more responsible by working towards a balanced budget and use budget surpluses (if we ever get to this point again) to pay down the national debt.

Aug 10 12:55 PM

[H.J. Huneycutt:]

Good article. I largely agree. The pursuit of a strong Dollar policy is flawed. The US Dollar needs to weaken to boost exports.

Aug 11 04:47 AM