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

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Includes: UDN, UUP
by: Lok Sang Ho

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.