Why a Strong Dollar Is a Terrible Idea

The dollar needs to be dispassionately evaluated for the costs and benefits of any particular price it bears, not misunderstood as a totem of national vitality.
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I recently had an e-mail exchange with an extremely distinguished conservative commentator -- a familiar name to most -- who was worrying that the dollar isn't getting the "respect" it used to.

This is, of course, largely true. But it also embodies an absolutely terrible way of thinking about our economic troubles that really has to stop.

What my interlocutor wanted, as a lot of people (and not only on the right!) seem to want, was a "strong" dollar. A strong dollar, like a strong defense or strong democratic institutions, sounds like just a naturally good thing. It sounds like something every American should want -- so long, of course, as they're not some sort of pinko-commie-freak socialist who secretly doesn't want America to succeed.

But they're wrong. A strong dollar is an unwise goal.

Why? Begin by remembering that the word "strong," when applied to currencies, is only a metaphor. The dollar is never literally "strong" like an army or even a cup of coffee is. What it is, is expensive or cheap, like any other thing that is bought and sold. Therefore the dollar needs to be dispassionately evaluated for the costs and benefits of any particular price it bears, not misunderstood as a totem of national vitality.

Remember, for one thing, that a "weak" currency can, paradoxically, confer national advantage. Germany, Japan and China all have undervalued currencies right now -- and all three are making out like bandits from this fact. They're laughing, all the way to the bank, much too hard to care whether anyone "respects" their currency. And they're quite happy to let Uncle Sam, eternal sucker of the global trading system, pursue that objective, because it helps them keep their currencies down.

Now that we've gotten the misleading metaphor out of the way, we can start asking the real question: should we want a high or a low dollar?

This question is obfuscated by those who would prefer that the public regard the matter as much too arcane for mere voters to worry about. (Better to let our trusty friends in the financial markets and the Treasury Department take care of it.) But it is really no different than any other question about the price of a thing: whether you want the price to be high or low depends upon whether you're buying or selling. If you're buying, you obviously want the price to be low, and if you're selling, you want it to be high.

Because we, as Americans, both buy and sell things with dollars all the time, the right price of dollars is going to be a compromise between these two needs. If the dollar is too cheap, then imports -- starting with oil -- will be too expensive. This will lower our living standards and cause inflation. Conversely, if it is too expensive, then imports will be too cheap and our exports will price themselves out of world markets. We will import too much, running up a trade deficit and destroying jobs.

As a result, there's nothing intrinsically good about a "strong" dollar. (Or a weak dollar, for that matter.) What's good for us is having an appropriate price for the dollar. Pace a billion complexities, it is, roughly, the price that balances our trade so that we run neither a deficit nor a surplus.

Will the good ol' free market deliver this price for us automatically? No, for two reasons. First, because foreign governments manipulate the dollar values of their currencies, they manipulate the foreign value of ours. Second, because the free market doesn't intrinsically care about time horizons. It can quite easily, in a nation with a bias in favor of short-term consumption, optimize short-term consumption at the expense of long-term economic health. (I explored this latter issue, which is grossly underappreciated, at length in this article.)

Some people confuse a strong dollar internationally with the stability of the dollar's value here at home. These two issues are related, but they're not the same thing. They're related because imports are about 17 percent of our GDP, which means that a lower dollar tends to make that chunk of our economy more expensive. But they're not the same thing, as is clear from the fact that a number of weak-currency nations, like Japan and Germany, have lower inflation rates than we do. Why? Because a lot of other factors get thrown into the mix, like the fact that the cheap capital flows that prop up the dollar lead to inflation in asset prices. If it's domestic inflation you're worried about, it's domestic cost drivers you should be focusing on. And don't forget that an unsustainably strong currency (as ours is) is building up inflationary pressures for the day the currency slides.

One can perhaps argue for an artificially cheap dollar so the U.S. can run a trade surplus which will create jobs and start paying back our vast accumulated foreign indebtedness. The problem here is, against whom would we run it? We're such a big economy that a trade surplus big enough to be meaningful for us won't disappear in the rounding errors of the world economy. If such a surplus ever happens, it will be a big factor globally. But the other big economic powers are (unlike us) wise to this game and probably won't allow their markets to be flooded with our goods the way we allow our markets to be flooded with theirs.

So balanced trade is probably the best we can hope for. The price of the dollar isn't the only thing that determines this -- tariffs, other trade barriers, and controls on international flows of capital also have their effect -- but it's certainly the biggest lever within convenient reach.

There are other problems with pining for a macho dollar. For one thing, one can't demand a strong dollar and simultaneously condemn Chinese currency manipulation. China artificially lowers the yuan-dollar exchange rate, making its currency cheaper in dollars and ours more expensive in yuan, in order to boost its exports and suppress its imports. As many people have argued, this is unfair to American producers. That's why there's a bill pending in Congress with 189 co-sponsors to retaliate against China for doing this.

Trouble is, if you want a strong dollar, then you should be down on your knees thanking Beijing for its currency manipulation, as that is precisely what this manipulation delivers.

Ultimately, it's not the dollar that's the object of anyone's respect. It's the strength of the American economy as a whole. If our economy is sound, respect will flow as a matter of course, regardless of exchange rates. The world is dazzled to some extent by the symbols and totems of power, but in the long run, real power always wins out. That's what we should be caring about.

This post has been updated from its original version.

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