Strong dollar cuts both ways

BUY MORE, SELL LESS: COSTLY EXPORTS A BIG AMERICAN PROBLEM

Dragging a trade deficit in its wake for 26 years, the US needs to boost exports, but its ability to do so by weakening the dollar is limited.

Perhaps no economics jargon has caused as much confusion as the “strong dollar”. The phrase suggests patriotic strength, of the USA riding roughshod over its economic rivals. In reality, dollar strength just means purchasing power — a stronger dollar lets the US buy more things from overseas, while a weaker dollar helps sell more things abroad. If you want more exports, weakness is strength.

Spit in the wind

Should the US pursue a stronger dollar or weaker one? Does it matter? President Donald Trump himself is reportedly unclear on the topic, and I can’t blame him. The US now buys a lot more than it sells. It’s trade deficit measured against GDP has remained in negative territory since 1992, nearly hitting -5% in 2006, recovering nearly half of that in 2009 after the financial crisis and now tracking -2.5%.

In the 1990s and early 2000s, the US was investing a historically normal fraction of its gross domestic product. This decade, however, the trade deficit remains high, while investment is much lower than normal.

From peaks of around 25% of GDP in the 50s, 70s and 80s, domestic investment fell to around 20% in 1992, nearly hitting 24% as the dotcom and subprime bubbles burst in 2001 and 2007, then falling to 17% in 2009 and now just above 19% of GDP.

That is worrying, since it means the country is living beyond not just its current means, but its future means as well. Without more robust domestic investment today, the trade surpluses needed to pay back foreign debts in the future will be harder to bear.

That could be a difficult adjustment for Americans in the future to bear, and could even lead to political unrest.

There will also be the temptation to inflate away the debt, which, if it got out of control, would be an economic disaster.

Since the US doesn’t have capital controls, weakening the dollar would mean getting the Federal Reserve to lower interest rates.

Right now it's doing the opposite the real cost of targeting exchange rates would mean that the Fed would surrender much of its power to use monetary policy to stabilise the domestic economy.

These days, US exporters are also big importers; instead of vertically integrated domestic producers, they are just one link in a global supply chain.

A weaker dollar would help their sales, but also raise their costs.

Simple lesson

Currency depreciations just don’t pack the economic punch they used to.

In the long run, the best way to eliminate the trade deficit might be to encourage Americans to save more and American companies to invest more. – Bloomberg