The Falling Dollar Isn't All Bad

by: Eddy Elfenbein

Tyler Cowan had an interesting article in the New York Times on Friday saying that a lower dollar isn’t all bad for the economy. He’s right. There are lots of good things that come from a weaker currency. For starters, it generally helps a country’s export sector.

Matthew Yglesias looks at the issue from a social justice standpoint and sees some benefits. Personally, I’m a bit leery of a country trying to devalue its way to prosperity, particularly because it involves picking winners and losers.

Of course, the currency is always being manipulated in some form, but I still don’t see how Treasury officials can better investors than the market. A lower dollar isn’t too much of a surprise given that our national debt is growing by $1 million a minute. I think when you get right down to it, people don’t like the idea of their currency getting pummeled on the world stage. It just looks bad.

Cowan writes:

But from a broader perspective, the value of the dollar hasn’t fallen quite as much as it might seem. Since President Bush started his second term in January 2001, to Nov. 20 of this year, the dollar has dropped 19.8 percent — if we weight the dollar by how much America trades with individual countries. That is a noticeable decline, but it is hardly a radical economic event. There are still many bargains, travel and otherwise, in Asia and Latin America for people paying in dollars.

A falling dollar does mean price inflation in the United States. Just as it costs more for an American to buy a fancy meal in Paris, so do French wines and German cars have a higher markup when they are sold in New York. But imports are only 16 percent of the American economy, and most foreign suppliers have been reluctant to risk their position in the American market by raising prices a great deal. Furthermore many price increases from Europe come on luxury goods and thus they fall on wealthy American buyers, who can afford it most easily. Wal-Mart (NYSE:WMT) serves a more working-class clientele and it is stocked with goods from Asia, where currency values have remained weaker against the dollar.

Of course, one of the benefits of a lower dollar is it allows certain lobbies to bitch and whine. The head of Airbus recently said that the weak dollar is “life threatening.” Sure pal, I feel your pain. And while you’re at it, why don’t you try building a plane on time for a change.

The Wall Street Journal notes this morning that the dollar could be ready to rally:

But currency markets are hard to forecast, and there is a case to be made that the dollar could be near a bottom.

One argument: Comparing what a dollar now buys in the U.S. (at U.S. prices) and abroad (at foreign prices) suggests that the dollar is undervalued. "You can't go to Europe and not think it's really expensive, and a European can't come to the U.S. and not think it's for sale," says Brad Setser, an economist at the Council on Foreign Relations.

The Organization for Economic Cooperation and Development calculates that $1 converted into euros could buy a basket of goods and services in France that would cost only 80 cents in the U.S. A dollar converted to yen would buy things that would cost 82 cents in the U.S. Over time, markets are expected to narrow such gaps by pushing up the dollar and pulling down the euro and yen.

Goldman Sachs economist Jim O'Neill says that by this measure, the dollar hasn't been so undervalued against major currencies since 1995. "You don't get these degrees of misalignment for long," he says.

You don't get these degrees of misalignment for long. But China wants to find out how long “long” is. Bloomberg also writes that a survey of economists expects a 7% rise for the dollar next year,

Almost exactly one year ago, I took a look at the dollar’s impact on the stock market:

The stock market has been freaked out lately due to the falling dollar, and the evidence shows that stocks prefer a strong greenback.

Since 1973, the dollar has risen on 4,189 days, fallen on 4,130 and stayed the same on 130. On the days of the higher dollar, the S&P 500 has risen a collective 2,356%, which is about 21.3% on an annualized basis.

On days of a falling dollar, the S&P 500 dropped over 55%, which works out to 4.8% on an annualized basis.

For the 130 days when the dollar is unchanged, the market is up 6.7%, or about 14.1% annualized.

Think of it this way, a weak dollar is basically the equivalent of a bear market for stocks.