Currency Confusion

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Includes: FORX, UDN, UDNT, USDU, UUP, UUPT
by: Bob McTeer

Thursday's WSJ had a front page article titled "Dollar's Rise Causes Pain in Europe, Asia". It began by stating that

A surging dollar and falling commodities prices are delivering a windfall to American shoppers and confounding central bankers by widening the gap between the expanding U.S. economy and struggling countries in Europe and Asia.

The first half of that statement is fairly obvious, but the second half is not.

If anything, a stronger dollar and weaker European and Asian currencies would tend to narrow the gap compared to the situation if currencies did not adjust, not widen it. Dollar appreciation would increase real purchasing power in the United States relative to countries with declining currencies due to falling import prices, but it would also shift demand in the other direction, toward the weak currency countries.

Policymakers worry about beggar my neighbor policies through competitive devaluation, not through competitive appreciation. That's why countries with sinking economies with downward pressure on their currencies are usually better off letting their currencies sink to competitive levels rather that drain their reserves in a futile attempt to hold onto a noncompetitive exchange rate.

Confusion over this point is commonplace and results from the lazy tendency to think of strong currencies as good and weak currencies as bad. One must distinguish between the goal of pulling out of or cushioning a recession and the goal of maximizing prosperity in a more stable situation. If our goal is to move U.S. growth from 2 ½ percent per year to 4 percent per year, an ever stronger dollar is not our friend.

To paraphrase St. Augustine's famous prayer about chastity, "Lord, give us a strong dollar, but not just yet."